Living in a demand-side world

I know what it's like to live in a demand-side world, because I used to live in one. Let me tell you about it. Maybe it's like the world you live in.

I wasn't stupid. I knew that potential output wasn't infinite, so there had to be a supply curve out there somewhere, but we never seemed to be on it. Firms almost always wanted to sell more output, and there were always some unemployed workers who wanted jobs if the firms needed more labour to produce more output. There might be occasional shortages and bottlenecks in particular sectors, but generally speaking output and employment were demand-determined. Supply was almost always bigger than demand.

Sometimes there would be inflation, but inflation could not have been caused by excess demand, because I could see with my own eyes that there was almost always excess supply. Inflation must have been caused by something else. Maybe there would sometimes be inflation in particular sectors due to bottlenecks in that sector, and that inflation might push up costs and prices in other sectors too. Or maybe inflation was due to monopoly power, in labour markets and output markets, that caused wages and prices to rise long before the economy got to full employment potential output and excess demand. Or maybe inflation was caused by conflicting claims over the distribution of income, where the sum of the groups' claims on output added up to 110%, so we got 10% inflation as each group tried to raise its price and nominal income relative to other groups.

Whatever the cause of inflation, it wasn't caused by generalised excess demand, and it didn't seem sensible to reduce aggregate demand to cure it. Even if the cure worked, which wasn't at all obvious since the cure didn't attack the underlying cause, the cure seemed worse than the disease.

So if output and employment were demand-determined, what determined demand? And how could we increase demand? It seemed sensible to divide demand up into demand by households, firms, government, and foreigners. Y=C+I+G+NX. So it was immediately obvious that an increase in G would cause an increase in aggregate demand, output, and employment. Indeed the increase in Y would generally be bigger than the increase in G, because if an increase in G caused an increase in Y, that would cause C to increase too, as households' incomes increased. And probably cause an increase in I too, since firms would invest more if they needed to produce more output to satisfy increased demand.

A cut in taxes was nearly as obvious a way to increase aggregate demand. If you cut taxes households' disposable income would increase, and so would their consumption demand.

Monetary policy was a little less obvious, but we conceded it might work too. If the central bank cut interest rates, that might encourage firms to invest more. But would firms really want to invest more to produce more output, if they couldn't actually sell any more output?

Sometimes we played around with Y=C+I+G+NX, to look at the same thing from a different side. I+G+X=S+T+iM told us that injections had to equal withdrawals, and if we wanted to increase Y we needed to increase injections into the circular flow, or reduce withdrawals.

So, if the cure was so easy, why didn't governments do it?

Well, they did. But sometimes they lost their nerve and chickened out from doing what needed to be done.

Some people would worry about government deficits and debts, even though we knew we owed it to ourselves, except for some of the debt that was held by foreigners.

Some people would worry that increased government deficits might push up interest rates. But they didn't have to, unless the central bank didn't cooperate.

Sometimes there would be a balance of payments crisis. If only we could have persuaded other countries to do the same as us in a coordinated fiscal expansion, or had just let the exchange rate float.

And sometimes governments would fear inflation. But we knew that inflation had to be caused by something else, and that the cure, if it was a cure, was worse than the disease.

I left that world: when I discovered we lived in a monetary exchange economy (like a fish discovering it swims in water); when I saw the Phillips Curve shift in the 1970's; when I discovered Milton Friedman, and learned not only that units didn't matter but that the rate of change of units didn't eventually matter either. But mostly I left that world when I discovered how to do macroeconomics with imperfect competition and learned how to see the world both ways at once. But I think I will leave all that for another post.

Any economist old enough to have learned macroeconomics about 40 years ago, especially in the UK, should recognise my old world.

Comments

[Mike Sproul]

We're about the same age, but I grew up in a supply-and-demand world, where rent control caused housing shortages, and price controls caused gas lines to form and emptied supermarket shelves of meat and paper products. Price floors on farm products and unskilled labor caused surpluses. Taxes and subsidies drove a wedge between buyers' prices and sellers' prices. When I started teaching economics in 1980, there never seemed to be enough classes for me to teach, so imagine my surprise when I heard department chairs complaining that they could never find qualified teachers. Yup. Supply and demand made pretty good sense.

One thing that never did make any sense to me was the claim that the government could make us richer by hiring the unemployed to dig holes and fill them in again.

[Nick Rowe]

Mike, supply and demand ruled in micro, but macro always seemed to me to be the real world. And I used to be able to make perfect sense of the claim that the government could make us all richer by hiring the unemployed to dig holes and fill them in again. The unemployed had zero opportunity cost, and even if the holes were useless, the other unemployed that got jobs producing goods for the hole diggers to spend their income on were producing something useful. Better still if the government dug some useful holes.

[Nathan Tankus]

"I left that world: when I discovered we lived in a monetary exchange economy (like a fish discovering it swims in water); when I saw the Phillips Curve shift in the 1970's; when I discovered Milton Friedman, and learned not only that units didn't matter but that the rate of change of units didn't eventually matter either. But mostly I left that world when I discovered how to do macroeconomics with imperfect competition and learned how to see the world both ways at once. But I think I will leave all that for another post."

Meh. What has any of that added? I think a shift towards developing harrodian growth models (and ultimately, looking at the world dynamically) and Minskyan financial instability was the shift economics needed. Milton Friedman and the rest was a big step backwards.

[Nathan Tankus]

@ Mike and Nick:

Man people really don't understand the sentences John Maynard Keynes wrote. First of all, the digging holes comment was meant to point out that generating demand leads to the production of wealth that wouldn't otherwise be produced even if incomes generated didn't initially come from something socially beneficial. Second, very obviously, Keynes would prefer money spend in social useful areas.

Third, and most importantly, his example was an attack on the gold standard. his original comment was about digging holes and throwing bottles of money in them that private individuals would then dig out. this was meant to be a dig at the socially uselessness of the gold standard and how gold mining under a gold standard was essentially doing what Keynes was describing. He was showing how the supply of money was inelastic in that a rise in the price of money (deflation) didn't bring about the production of more money like neoclassical theory claims about the supply of a traditional (or "normal") good.

[Mike Sproul]

Nick:

The unemployed give up leisure time, training opportunities, job search, and hunting and gathering, all of which are valuable. Where did their pay come from? The government either got it from taxing, borrowing, or printing, so that the new spending by the unemployed was offset by reduced spending elsewhere.

[Nathan Tankus]

@Mike you're making the pernicious assumption of full employment.

[Mike Sproul]

Nathan: Actually, to us micro guys the phrase "full employment" has no meaning. But whether people in general are employed or not, taking money from working people and paying people to dig holes will make us poorer, not richer.

[Nathan Tankus]

@Mike: I'll define what i mean by full employment: zero involuntary unemployment (as in they would prefer to work but can't find a job or get more hours for economic reasons). That doesn't include "frictional" unemployment being the time it takes to transition to another job.

"But whether people in general are employed or not, taking money from working people and paying people to dig holes will make us poorer, not richer."

This is just nonsense. what could you possibly mean that it doesn't matter whether people are involuntary employed or not? Employing people who want a job but can't find one gives them a source of income and means producing more output then would otherwise be produced. It is true that the activity of digging holes is not directly productive (something no one claimed or desires as a policy) but it does increase demand and cause the production of more output (ie more real income). it also preserves human capital that would otherwise get destroyed due to hysteresis (in the economic sense).

Second, there is your whole assumption that increased spending has to come from higher taxes. as you yourself pointed out, this can also come from issuing no yield government bonds (you called it "printing money") and some yield government bonds (treasury securities). Only taxation "reduces spending elsewhere. I want to meet the insane person you know who cuts their spending when they otherwise wouldn't because they say to themselves "well before i had 10,000 of zero yield bonds so i can spend as i please but now i have 10,000 of yield bonds so i have to cut my spending".

I must reiterate, no one really wants digging holes to get money (the gold standard), the point is that that can increase output in times of sever underemployment (not to mention the social benefits of lowering unemployment).

poverty is defined as "the state of having little or no money and few or no material possessions". the whole digging may not be the project you or i want people to be hired to do, but it does increase income and it does increase the material possessions of the society as a whole. If you say that it reduces overall utility because of the leisure time lost, while i don't know how to interact with someone who thinks unemployment is caused by people who suddenly prefer leisure to employment in droves.

[Ramanan]

"Some people would worry about government deficits and debts, even though we knew we owed it to ourselves, except for some of the debt that was held by foreigners.

Some people would worry that increased government deficits might push up interest rates. But they didn't have to, unless the central bank didn't cooperate.

Sometimes there would be a balance of payments crisis. If only we could have persuaded other countries to do the same as us in a coordinated fiscal expansion, or had just let the exchange rate float."

Nick Rowe or Nick(olas) Kaldor ??? :-)

(Except Kaldor wouldn't agree on floating the rate because of the Kaldor paradox).

But seriously a nice summary of your world - even though I disagree with your viewpoints and fail to understand how you jumped to the other side in the 70s. I guess Friedman had great hypnosis skills :-)

Have you read the article "What Is Wrong With Monetarism" by Francis Cripps? It's my favourite all time article summarizing the Keynesian viewpoint (although taking Keynesianism to task as well). Appears in a book titled Monetarism, Economic Crisis and the Third World, edited by Karel Jansen.

[Scott Sumner]

I remember those days. The key discovery was that changing the trend rate of inflation (within reason) had no impact on the average rate of unemployment. Old Keynesians and post-Keynesians couldn't deal with that, and still can't.

The profession moved on, but whenever the issue of changes in trend inflation seems to go away, the old Keynesians crawl back out of the woodwork.

[Frances Woolley]

Nick, when I read your post, for some reason I thought of the Monty Python gas man sketch here . The point being that the demand-side world you remember was only so demand-side - there were all sorts of institutions that constrained supply and limited price movements.

[Nathan Tankus]

Scott:"The key discovery was that changing the trend rate of inflation (within reason) had no impact on the average rate of unemployment. Old Keynesians and post-Keynesians couldn't deal with that, and still can't."

that just simply isn't true. perhaps of the "old keynesians", but certainly not the post-keynesians.

[Determinant]

OK Nick, but how do you reconcile your new knowledge with your theory that recessions are everywhere and always a monetary phenomenon with the corollary that you do not believe in supply-side contractions and certainly not that the 1970's was one?

I say the 1970's was a contraction. The 1982 "episode" was a contraction too, it was central banks purposefully lowering the money supply and jacking up rates. But the present crisis is not a supply contraction, it is a recession, a demand side phenomenon. Like the old demand-siders you want to see economic slumps as due to one mechanism only, where I say there are two mechanisms.

In my world, there can be supply problems and demand problems and the strategies to resolve the two are very different. The details are different too. Using the wrong strategy in a crisis will only make the problem worse.

[Kevin Donoghue]

Nick, this reads a bit like one of those How I Lost My Hash-pipe and Found God stories which are a staple of certain Christian publications. I'm sure your younger self was a lot more clued-in than you give him credit for. Friedman published his QTM "restatement" in 1956. It's not at all likely that you first discovered him in the 1970s.

If you want to do justice to the young Nick Rowe, I'd suggest digging out your copy of Clower's Penguin collection of readings and having a fresh look at what he was actually wrestling with.

[Bill Woolsey]

I presume that Nick thought the 1956 Friedman was a right wing nut.

The way I tell this story (and not about myself,) is that not only did inflation get worse in the seventies, unemployment was not expecially low.

And then, when inflation was brought down in the eighties, unemployment did not stay exceptionally high.

Personally, during much of that period, I thought Friedman was too "left wing," proposing a low rate of legalized counterfeiting due to his wrongheaded fixation on a stable price level.

Nick's point is that measured and ubserved unemployment and excess capacity appears to be consistent with market clearing prices and wages. In my view, in ordinary times, excess capacity is malinvestment. Not because of interest rate issues like the Austrians emphasize but because of changes in the composition of demand more generally. Specific capital goods for import competing industries in the face of more competitive foreign exports, for example. But technological change results in obsolete specific capital goods every day. Some of that umemployment we observe exists even though wages are at market clearing levels, it is just that actual employment is less than equilibrium with vacancies matching unempoyed workers. But some of the unemployment is more like the "malinvestment" in specific capital goods, it is just human capital. While generally people can start over, it is difficult to make this adjustment.

Ramping up demand in aggregate just doesn't make all of this go away, because the problem is the composition of demand. But I think it leaves lots of room for temporary booms. And more importantly, none of this means that low demand doesn't cause problems. I do think that it is conceptually possible that they can be solved by a lower growth path of prices, including wages. Before the prices (and wages) make the full adjustments, expansion in demand can fix up the problems, making it unnecessary to make the price adjustments.

The Rothbardian view (which was mine in about 1978,) was that prices and wages should just be flexible enough so the real quantity of money will adjust enough so that real expenditure will adjust to maintain full employment. Whatever the level of nominal demand, prices and wages should adjust so that the unemployment and excess capacity we observe remains due to shifts in the compostion of demand and changes in technology, along with frictinal unemployment where vacancies match unemployment.

The old monetarist view was that the demand for money stays on an almost costant growth path, and so, keeping the M2 measure of the quantity of money on a constrant growth path will keep nominal expenditure on output growing on a constant growth path. There would be no need for prices or wages to shift off of their growth path to keep real expenditure consistent with full employment.

Interest rates can't have much effect on the demand to hold money, so saving, investment, deficits, and the like, which plausibly impact credit markets and market clearing interest rates have no impact on nominal spending on output as long as the quantity of money stays on a stable growth path. Or so "we" monetarists told ourselves.

While the Rothbardian view was that prices and wages should adjust if needed, the claims that these changes in nominal expenditure would be rare because the demand for money won't change much were somehwhat important.

But that argument stopped fitting the facts. There is no measure of the quantity of money whose demand stays on a more or less constant growth path.

I favored targeting the price level for many years. Adjust the quantity of money however much is needed to accomodate changes in the demand to hold money and keep the price level constant. Suddenly, concerns whether the demand to hold money is impacted by interest rates became pointless. Do you mean the interest paid on money or the interest rate on other assets? So what? We need a monetary regime that keeps the quantiy of money equal to the demand to hold money at a stable purchasing power. Hayek's Denationalization of money and Greenfield and Yeager's Black-Fama-Hall payments systems promised just that.

But what of "supply shocks?" Does it really make since to force the prices of everything else down because there is a bad harvest? It was really George Selgin that convinced me. Not that there is any advantage to a trend deflation in final goods prices, but rather than trying to keep final goods prices on a stable growth path in the face of shifts in productivity, and especially supply shocks to particular markets.

The market moentarist answer is to target nominal GDP and to change the quantity of money however much is needed to keep nominal GDP on target.

While that was my position since the early nineties, I must admit that the apparent success of the Fed in using some kind of quasi-Taylor rule pretty much shut me up. Sure, I still prefered zero inflation to 2%. But they seemed to be doing a pretty good job in adjusting the quantity of money to the demand to hold it.

Then, they screwed up in 2008 and haven't fixed the problem yet. It is time for a change.

[Nick Rowe]

Kevin: "Nick, this reads a bit like one of those How I Lost My Hash-pipe and Found God stories which are a staple of certain Christian publications."

LOL. That was about the style I was aiming for! (The former, by the way, is still buried deep in the ventilation system of a 1967 Landrover, I think.)

"Friedman published his QTM "restatement" in 1956. It's not at all likely that you first discovered him in the 1970s."

Come on, I'm not that old! I couldn't read in 1956! A-level economics 71-73 (pretty sure I was in the same class as the economics editor of the Grauniad, BTW). Some economics courses (it wasn't my major) as undergrad 73-77, where IIRC I read some of Friedman's ideas second-hand in my own readings. Then properly introduced to QTM etc. 77-78 doing my MA, then PhD. Clower's penguin is on my office desk, I think. I'm still wrestling with it.

[Nick Rowe]

Determinant: "OK Nick, but how do you reconcile your new knowledge with your theory that recessions are everywhere and always a monetary phenomenon with the corollary that you do not believe in supply-side contractions and certainly not that the 1970's was one?"

Same as (almost) everyone else (RBC people aside). Booms and recessions are demand-side fluctuations around a supply-side that doesn't fluctuate much.

Thanks Ramanan. Yep, in part, this post was a "I too was a sinner like you before I lost my hash pipe and discovered God". But it was also a conjecture on my part. Because I really wasn't sure if my old sinful beliefs are roughly the same as those of current "Post Keynesians". It helps to be able to get some idea of where people on both sides are coming from. A bit less miscommunication.

Nathan: I think you have given me the title for my eventual follow-up post: "Why the Aggregate Supply curve isn't really an aggregate supply curve". I think a lot of confusions really are semantic, in part.

[Becky Hargrove]

I wish I had something good to contribute today, I don't. Hang in there Nick at some point these things will become more clear.

[Jciconsult]

The issue is whether figuring out that markets are imperfect (often very much so) leads to you understand that we need societal agents such as government to get socially acceptable results. That the supply side is constrained (at least in terms of the absolute supply of labour) is a reasonably sensible conclusion. The issue is how to get the most out of the stable supply side that we have and not to expect miracles of supply side expansion.

[Skyman123]

"...taking money from working people and paying people to dig holes will make us poorer, not richer."

It doesn't take a lot of mental gymnastics (even if your brain is flabby from only eating and not exercising) to understand the complete ludicrousness of the above statement. My mind, perhaps naturally as a CEO, wanders over this situation: "business is suffering from a lack of demand and, therefore, not hiring. Nor are conditions good for capital investment. So we all just sit around twiddling our thumbs waiting for something, anything to happen as over-indebted consumers sit there, wages go nowhere, and demand stays slack". And then I think of this statement and my mind naturally says "well, even if we tax people leaving them a tiny bit less disposable income and employ people digging mythological holes and filling them in again, at least the aggregate of these people have more money to spend than the tiny bit we took from many who won't alter their consumption patterns at all and who will turn around and spend it producing multiplier effects that, even at the margin, translate into a bump in demand."

But maybe some of you live in nicely insulated academic worlds and aren't really operating on the ground like most of us. I wish you'd all just shut up sometimes because you're not helping at all. It's like watching people debate how many angels can dance on the head of a pin again. Really, have we not progressed at all since the middle ages?

[W. Peden]

To be fair to the Medieval Scholastics, the "How many angels can fit on a pin?" question is actually a perfectly good philosophical question to flesh out the problem of the extensionality (or lack thereof) of the mind-

http://en.wikipedia.org/wiki/How_many_angels_can_dance_on_the_head_of_a_pin%3F

It's an example of how genuine but difficult questions can be simplified into more concrete intellectual problems, which is a perfectly legitimate and good procedure in economics as well as in philosophy.

[y]

how many hot potatoes can you juggle on the head of a pin?

[Skyman123]

Honestly, y, while Peden is musing upon that the rest of us will produce goods and services. When the zombie apocalypse happens, perhaps Penden will be like veal from lack of real work, and tender.

[Jon]

Nick: beautiful post! I read it screaming inside waiting for just the punchline you made.

[Nick Rowe]

In the Old Keynesian model, holding the rate of interest constant, the balanced budget multiplier is one. One hole in the ground, if that's what G is spent on, nothing more.

Jon: thanks! You an old Brit too?

Scott: yep. The Friedman Phillips Curve was a big part of it. But there was always that ambiguity in Friedman between two readings of the Phillips Curve: from output to inflation, or from inflation to output. Was the Phillips Curve an aggregate supply curve?

Bill: "While that was my position since the early nineties, I must admit that the apparent success of the Fed in using some kind of quasi-Taylor rule pretty much shut me up."

Similarly, I was never really comfortable with seeing the interest rate as a short-term target for monetary policy, but the success of the Bank of Canada in adjusting the interest rate to keep inflation on target pretty much shut me up too. Hey, it seemed to work fine, so perhaps I should stop worrying whether all the angels could fit on the interest rate pin. Then 2008, and especially the Fed.

[W. Peden]

Nick Rowe,

"Was the Phillips Curve an aggregate supply curve?"

Is it?

Skyman123,

I didn't say I mused on it at all. I just said that it's a genuine question. Incidentally, academia is a service industry; academics just pretend it isn't, and from the point of view of a student sometime it really isn't.

[Nick Rowe]

W Peden: ""Was the Phillips Curve an aggregate supply curve?"

Is it?"

Not, IMO, in the normal sense of "supply" curve, even for the Long Run PC. But then there isn't a normal sense of "supply", under imperfect competition.

[Nick Rowe]

Nathan: "@Mike: I'll define what i mean by full employment: zero involuntary unemployment (as in they would prefer to work but can't find a job or get more hours for economic reasons). That doesn't include "frictional" unemployment being the time it takes to transition to another job."

Is that a *useful* definition of "full employment" if we are talking about aggregate demand (fiscal and/or monetary) policies? To say the same thing another way: can AD policies actually get us to "full employment" in that sense? (I mean sustainably or on average, or, even if they had perfect foresight of shocks, because we know they will make mistakes on either side.)

Ramanan: "Have you read the article "What Is Wrong With Monetarism" by Francis Cripps?"

I can't remember. I may have done. There were lots of articles with titles like that in the 1970's.

OK. I just read what I could of it on Google books (not all pages available). OK, he wrote it in 1983? Two points:

1. Like old Brits in the 1960's and 1970's, he's hung up on balance of payments constraints. This is beating a dead horse. I take flexible exchange rates as my maintained assumption, like a good Canadian (Canada broke with Bretton Woods fixed exchange rate system, with the full support of Milton Friedman).

2. He assumes monetarists assume perfect competition. In 1983 (when he wrote that paper) perfect competition was all that macro-modellers could manage to do. In 1985 I wondered whether the main tenets of monetarism would survive relaxing the assumption of perfect competition, and managed to build a macro model with imperfect competition, and taught myself that (by and large) they did. The seminal paper by Blanchard and Kiyotaki came out in 1987. Nowadays this is standard. New Keynesian models of the Phillips Curve are explicitly built on imperfect competition. Actually, something like a Friedmanite expectations-augmented Phillips Curve is a helluva lot easier to build if you assume imperfect competition. It's hard to make it work right under perfect competition.

[Nathan Tankus]

@Nick: I think it is a useful definition of full employment, and no I don't think traditional "pump priming" can get us there on a sustainable basis. This was Minsky's major point in the 1960's (and later) and i think he was vindicated spectacularly. This is one reason why a direct jobs program is supported by Minskyans and Chartalists (but i don't think you want to get into that). To really preserve high to full employment on a permanent basis you need automatic stabilizers, not discretionary policy. I think the job guarantee is a good automatic stabilizer but i can imagine a case for some others that would work well (but i don't think as well).

[Nick Rowe]

Nathan: Did you ever see my old post where I (indirectly) discussed it?

It's maybe useful to distinguish between the JG as a macro monetary/fiscal automatic stabiliser/nominal anchor (like an artificial gold mine) as discussed in my post, and as a micro policy designed to reduce the natural rate/NAIRU.

Many micro policies could (in principle) reduce the natural rate/NAIRU. Which particular micro policies would work depends on your theory of the natural rate/NAIRU. Efficiency wage? Monopoly union? Adverse selection? Frictional/search? Etc. You really need a theory of the natural rate to tell you which micro policies would work to reduce it, and whether the benefits would exceed the costs.

The concept of "full employment" that is most useful for macroeconomic AD policy may be very different from the concept that is most useful for micro policy.

[Deus-DJ]

Nick Rowe,

What do you think all of this fuss about an endogenous money supply has been about?! You talk about how you discovered Friedman, but if you've read Moore's papers and book in particular and *know* that the money supply is endogenous like the rest of us do, then you would know that Friedman has been utterly discredited. Everything he did was simply wrong. Look, his writing was flawless, and brilliant...I know why he attracted minds like yourself. But he was wrong.

[Deus-DJ]

the natural rate of interest is 0

[Nick Rowe]

DDJ: Oh God. (Pours himself an Irish.) Did that comment really move the conversation forward? Is this post about endogenous money? Do you mean the same thing by "endogenous" that I might mean by "endogenous"?

Tell, you what, have a read of my recent post which is about modern monetary theory of inflation targeting central banks (which is what modern central banks do), in which the stock of money is very much endogenous.

[Nick Rowe]

DDJ: "the natural rate of interest is 0"

This raises an interesting and important question: why does MMT seem to attract people like DDJ?

[Nathan Tankus]

@ Nick: as you know, I don't accept the theoretical basis of the non accelerating inflation rate of unemployment. I think there are all sorts of unemployment rates consistent with all sorts of inflation rates and the ad hoc nature of the neoclassical treatment of institutions (through transaction costs, unions, minimum wage policy etc) is highly problematic.

Have you seen the latest literature around the NAIRU? it's a joke. they have revised their estimates to say that the PIIGS NAIRU was much higher since the crash and Germany's was lower (the u.s is only a percentage point higher then it was before).

I don't think one needs any kind of natural unemployment rate theory to discs these phenomenons, although one should have an integrated dynamic economic theory.

[Nick Rowe]

Nathan: agreed that the theory underlying the SR Phillips Curve is the weakest of all important areas in economics. (The Calvo fairy is mathematically tractable, but other than that......). But one does come back to the idea that the units shouldn't matter. We get the same rate of unemployment whether we measure prices in dollars or in cents. Sure, we cannot tell what the natural rate is, certainly not in real time, and even barely in hindsight. Which is one main reason why we shouldn't use AD policy to try to target it.

Whose kid is DDJ? Can they keep him on a tighter leash?

[Deus-DJ]

...so on the one hand we shouldn't try to target it, but on the other hand we should assume its there and be content to leave unemployment at a certain level...gotcha! btw, fine, maybe your post doesn't have much to do with endogenous money per say, and more inflation expectations(sorry, when I think Friedman I immediately think **exogenous exogenous** rather than expectations augmented PC). I need to look at your recent post before I respond again. Regardless, if you believe in endogenous money then it makes little sense to speak of monetary policy(ie money growth) with respect to inflation expectations and drawing some LRPC with some NAIRU...

And I would like to know what you're thinking in terms of why MMT/PK attracts people like me? I would answer that maybe because we don't make models based solely on expectations...rather we'd like to see what the real world looks like first and create a theory based on the empirical data...like understanding that stagnating and declining incomes is important (see this pathetic paper: http://www.frbsf.org/publications/economics/letter/2012/el2012-11.html).

unfortunately I've been off the leash for a while now, you and others will have to deal with my sometimes uneducated self at times ;)

on the topic of administered prices and neoclassical theory I will return later

[Nick Rowe]

BTW, a couple of years back I asked this question of MMTers. I never really got an answer. What is their theory of the Phillips Curve? You can't do a 1970's flashback (Kevin's hashpipe is not precisely correct, I now realise) as if the constraint was still balance of payments, fixed exchange rates and gold reserves. The world has moved on. Everyone now (Eurozone aside) automatically assumes countries have flexible exchange rates and inflation targeting (or similar). It's a bit like coming across those Japanese soldiers hiding in the jungle, still fighting WW2. The CPI standard has replaced the gold standard. So, what determines the CPI? How does the CPI, and its rate of change, relate to output and employment?

[Deus-DJ]

btw, maybe the existence of an NAIRU attracts people like Nick Rowe to neoclassical economics? IMO: it makes the real world solutions much more easier to come go grips with; allows you to make formal models that excludes a great many variables; allows one to believe in the enticing proposition that if you really understand economics, you would understand that what sounds intuitive isn't actually the optimal solution; and that unemployment is not a policy variable but is one that is largely out of our hands at the NAIRU, and hence its justified.

ok, big straw man obviously, and you are a little unorthodox so its not fair to you at all, but it was fun.

[Nick Rowe]

DDJ: It's my job to deal with uneducated (in economics) people. No worries there.

Let me educate you a little. Saying "The natural rate of interest is 0%" is a sensible thing to do if: you say it when it's relevant to the discussion at hand; you explain what you mean by that; you give some sort of explanation why you believe it to be true. You did none of those things. People like Scott F or Warren M would have done those three things. That's the most important thing you could learn from them.

Now read my post and also learn that monetary policy is not the same thing as a target for the rate of growth of the money supply. The latter is just one very particular type of monetary policy. Most modern central banks target inflation, not the growth rate of the money supply. If you are going to be a Modern Monetary Theorist, you need to understand modern monetary policy. Whether inflation targeting is a good monetary policy is another question.

[Nathan Tankus]

I don't have a direct answer to your question, but i would like to point out that the original William Phillips was a dynamic engineer with a much more complicated and versatile concept of the relationship between inflation and unemployment. It was only afterwords did the neoclassical economists (eg Solow and Samuelson) get their hands on it and, in typical comparative static fashion, simplistically state that "when inflation is high, unemployment is low and vice versa".

I would also like to point out I actually think your characterization of the "mmt" position presented in blogs is pretty fair. It has been one of the more frustrating things for me, whom you could call "an advanced student", that they have spent no time on heterodox microeconomics nor even on the work of their colleague at UMKC Fred Lee. I generally follow the full cost pricing analysis he has helped resuscitate. If you want more adequate treatments of pricing theory and "supply" in a Post-Keynesian tradition, his work is where I'd go (indeed am going).

Phillips early papers:

http://www.jstor.org/stable/2549721?seq=2

http://www.jstor.org/stable/10.2307/2226835

Sample Fred Lee paper:

http://www.jstor.org/stable/2662703

[dilletaunted]

"This raises an interesting and important question: why does MMT seem to attract people like DDJ?"

It's also interesting how Market Monetarism attracts people like Morgan Warstler, who has repeatedly referred to Warren Mosler as a "tard," and is a regular at Sumner's blog. He and Scott have a nice rapport.

I'll take DDJ over that miserable misanthrope any day.

[reason]

Mike Sproul
"The unemployed give up leisure time, training opportunities, job search, and hunting and gathering, all of which are valuable. Where did their pay come from? The government either got it from taxing, borrowing, or printing, so that the new spending by the unemployed was offset by reduced spending elsewhere."

PLEASE tell me this is a parody! (How does printing money take money from anybody? - And I didn't see the bit about conscripting the unemployed - my impression was that taking the government job was voluntary.)

[Nick Rowe]

Nathan: thanks. Yes, Bill Phillips was a far more sophisticated thinker than the simple "Hey look, there's a curve here!" view would make him out to be.

Understanding the MMT position is really not easy. It would be unfair of me to say they should ditch the name "MMT" and call themselves "That 70's Show", but there would be some truth in it. It is not an obviously stupid position to say that macro took a wrong turn in the 1970's, and to say we need to go back there and try to take a different path forward. (After all, you could argue that Milton Friedman did something similar.) But their saying that their critics are still thinking in some sort of Gold Standard/fixed exchange rate terms is really tilting at some defunct 1960's windmill. It's the Phillips Curve that is the constraint on monetary policy. It's the CPI (or whatever) standard, not the gold standard.

(And the next time one of them resorts to some sort of false modernism, and talks about science progressing one funeral at a time, I think I will repeat my dirty crack about "That 70's Show".)

dilletaunted: touche. Morgan does grow on you over time, though. Very very slowly. Actually though, I see him more as a troll on Scott S's blog, who has very slowly been partially converted to MM by Scott.

[Kristjan]

If you understood the monetary operations MMT describes then you would not be talking about hot potatos.

[deus-dj]

But I must admit, and u must too kristjan, that talking about and visualizing hot potatos is so much more appealing, especially to those that want to give themselves authority.

[Nick Rowe]

Kristjan: If you make an assertion like that, and fail to explain how it is related to the conversation here, what you mean, and why you believe it, you are not moving the conversation forward. It just comes off as wildly defensive flailing about, trying to change the subject by laying down a red herring.

DDJ: one more thing you need educating on: you are now holding a conversation in my living room. I am your host. Mind your Ps and Qs.

Both of you: go read Nathan above to learn how to hold a proper conversation that is actually useful.

[W. Peden]

"I would answer that maybe because we don't make models based solely on expectations...rather we'd like to see what the real world looks like first and create a theory based on the empirical data"

This kind of talk really worries me. It's not that I think empirical data is bad or the real world is unimportant. It worries me because it assumes that there is a non-theoretical stance from which economic phenomena (or any phenomena) can be observed scientifically and we can somehow infer theory from these non-theoretical observations.

Theories tell us what data to look for, what sort of data to construct, what sort of observation methods don't affect the observed, and what constitutes significant patterns across the data. There is no way of "seeing what the real world looks like" prior to that, and any attempt to do so opens up the possibility of a very harsh dogmatism because one confuses observations based on one's own assumptions with indisputable "real world" data. It brushes over the first challenge in scientific methodology: what you see depends on where you sit.

(It also worries me because of the assumptions about models e.g. I can't think of any models I've read that were based solely on expectations.

[W. Peden]

Nick Rowe: I am envious of your patience and politeness.

[philippe]

The great thing about blogs is that anyone can participate in the debate and people can be completely anonymous if they so wish. This is also one of the worst things about blogs.

You end up with people going around making all sorts of simplistic statements and misrepresenting other people's views. This happens on occasion with MMT. I'm interested in it personally but don't know enough to be able to give a proper account of it. Anything I say is simply my own dumb opinion. I'd be horrified if people thought my occasional simplistic MMTisms were authoritative accounts of MMT.

I'd say a lot of people who might not otherwise be on economics blogs are interested in MMT because of a) the financial crisis and b) the sovereign debt crisis. MMT seems to provide clear insight into both and clear policy options for solving both.

Also MMTers often say things which are basically true and that others completely ignore. Such as, a state that issues it's own currency can't 'run out of money', and that the real constraint on budget deficits is inflation. Statements like this are appealing because they make most of what passes for informed debate in the media seem like total nonsense. Other statements such as deficit spending with newly-created money not necessarily being any more inflationary than deficit spending with bond issuance, are more difficult to grasp at first but pretty mind blowing once you get it. Then there's the fact that banks really do create money, also pretty awesome for someone like me.

Personally, I was really struggling to understand what the hell was going on from 2008 onwards until I came across MMT, but that might not be saying much (I'm in arts, not economics). But there is a lot more to MMT which is questionable. I think you make really great and important comments, Nick, and I appreciate the fact that you take the time to critique the MMT crowd. I think 'that 70s show' might be a bit harsh though - there's much more to it than that.

[Nathan Tankus]

@Nick: to be fair, there are people around that still think in Gold Standard terms (although I think a few MMTers use it as a weird hand-waving catch all). This has been my other frustration, they've done the hand-waving "inflation is the only constraint on fiscal policy" without actually delving into price theory. There actually have been a lot of developments in heterodox price theory, but "MMT" has made literally no attempt at translating it into their blogging.

[Determinant]

Has anybody else had this earworm yet: "We all live in a Demand-side world, and I am a Demand-side Girl!!!!2" ;)

[Kristjan]

I admit It was a little out of topic here Nick(considering your post). You were talking about MMT few comments earlier so It really gets me how you cannot get the basic ideas of It.

1.Is It possible at all for the quantity of reserves to be endogenous?
2.What would need to be done to make the quantity of reserves endogenous?
3 Let's say you would become the chairman of the federal reserve and your task would be to make the quantity of reserves endogenous. What would you do?
4.Is It possible that bank lending is not reserve constrained? If yes, then how? What needs to be done for it not to be reserve constrained?

I am just trying to find out how you think about It since you are intelligent IMO.

[Winslow R.]

Imagine how this story would change if Nick had been born in 1910.

[Mike Sproul]

Reason:
"How does printing money take money from anybody? "

The newly-printed money normally would be lent to someone, who might use it to buy a car. If the government instead uses that money to hire the unemployed to dig and fill holes, then the world is poorer by 1 car.

[philippe]

Nathan Tankus, I don't know if this is of any use:

Full Employment and Price Stability, Prof. Paul Davidson (1997)

Exogenous Pricing: A Basic Case of Monopoly

quote:

How does the monopolist price his product? There are two options:

1.Set price, p, and let quantity, q, float, or
2.Set q and let p float.

The first option is generally preferred, with a gold standard or the proposed ELR program two examples of using the first option.

cont...

http://moslereconomics.com/mandatory-readings/full-employment-and-price-stability/

[philippe]

"The newly-printed money normally would be lent to someone, who might use it to buy a car. If the government instead uses that money to hire the unemployed to dig and fill holes, then the world is poorer by 1 car."

Not sure why these should be mutually exclusive, could you elaborate?
Also, the money spent employing someone filters through the system, moves from one person to the next. Someone might use it to buy a car. It also has a added benefit of having no private liability or debt attached to it, unlike a loan. Not that it would be worth paying someone to dig and fill in holes. That's a waste of time and labour.

[ArijitBanik]

I am sure that there will be a truly 'worthwhile' post someday.

[Nick Rowe]

Nathan: "@Nick: to be fair, there are people around that still think in Gold Standard terms...."

Among non-economists, many. But funnily enough, the only name that comes immediately to mind, if we are talking educated economists, is our Mike Sproul who is commenting here. (Is that roughly correct, Mike?) He is a rare bird, and can argue his position cogently. Click on his name to see his writings. But Mike's position is very far from mainstream. He is definitely not a monetarist or quantity theorist. He and I have argued to a stalemate over the years.

Back later.

[Nick Rowe]

ArijitBanik: "I am sure that there will be a truly 'worthwhile' post someday."

And that was a really useless stupid comment, that did absolutely nothing for the conversation here. Did you read any of the above comment thread? I have been very patient and polite. Enough. Get lost. Don't come back, until you have learned some manners and commonsense. Oik.

[Nick Rowe]

philippe: "Also MMTers often say things which are basically true and that others completely ignore. Such as, a state that issues it's own currency can't 'run out of money', and that the real constraint on budget deficits is inflation."

Suppose I said to the Bank of Canada: "Print as much money as is needed to keep inflation at the 2% target, and hand the revenue from printing that money (minus your expenses of paying salaries etc.) over to the government!"

Would you associate that directive with the MMT position? Because if I told the Bank of Canada that, they would look at me strangely, and reply: "Nick, you know very well we are already doing that."

It's totally mainstream economics. It works out a bit over $2billion a year, on average, last time I looked. A nice little earner, but no real biggie. They could make it a bit bigger if they wanted, by targeting higher inflation, or bringing back reserve requirements and not paying interest on reserves, etc.

[Nick Rowe]

Kristjan: It's been slowly dawning on me this last few days, especially since I read Milton Friedman this morning using the same word on a weird way, that people mean many different things by "endogenous" and "exogenous".

Tell you what, swap the word "reserves" for "stock of money" in your questions, and I have my (approximate) answer right here, in the post I did a couple of days ago.

Under inflation targeting as currently done by the Bank of Canada, the stock of money (and by extension reserves) is "endogenous" in the normal economics sense of that word (which might not be what you (or Milton Friedman) means by "endogenous".

[philippe]

Ok, good point.

But then do you mean to say that if the government were to significantly increase deficit spending (and this was to be accomodated by the central bank), this would result in higher inflation? Because of course this is not what the MMTers argue (at least not if the spending is done in the way that they advocate).

What MMTer's might describe as the 'imaginary sovereign debt-default risk', is currently being used by numerous governments to massively cut back public spending. In general the argument goes: "we've run out of money, there's nothing we can do but cut social security and sack teachers. Sorry".

The argument is often made that if the deficit isn't reduced then the US could end up like Greece. This completely ignores the basic difference between the two countries, in terms of their abilities to issue their own currencies and repay debts.

From the MMT perspective the current debate on deficit unsustainability is completely wrongheaded. Even if the argument were rephrased in terms of inflationary risk rather than default risk, the argument against deficit spending would still be wrong, as far as they're concerned. I'm assuming you would disagree with this? Could you explain why, if you do?

[philippe]

Also, assuming the treasury could issue new money directly, do you think that financing government deficits with newly-issued money would *necessarily* be more inflationary than spending with 'borrowed money' (i.e. issuing bonds)?

(Sorry if you've been over this already, I only started reading your blog very recently).

[philippe]

*('increase the deficit' includes cutting taxes, of course).

[Mike Sproul]

Philippe:

The fed prints $20,000 of new money. If the fed lends it to a guy who uses it to buy a car, then he has a car, the car maker has $20,000 which he uses to buy steel, etc.

If the Fed spent $20,000 digging and filling holes, then the diggers have $20,000, which they spend. The end result is that the world has a filled hole instead of a car. Frederic Bastiat famously explained this as the "Broken Window Fallacy" in "That which is seen and that which is not seen"

Nick:

Correct.

"Rare bird" I like that.

[Nick Rowe]

philippe: short answer: the US is very different from Greece, because the US can print money and Greece can't. The debate between monetarists and keynesians (crudely) is over whether printing money to buy back government bonds is enough. Keynesians say it's not enough at the moment. This is the worry about deficits: when the US economy recovers, and it must stop printing money to avoid inflation, it *may* have to increase taxes by more than it otherwise would if the debt is higher.

[Kristjan]

Thanks Nick. That post of yours is based on loanable funds. I've read Friedman a little, wich material you were reading( where he talks "endogenous" "exogeneous")?

[Nick Rowe]

Kristjan: the ISLM is a mixture of loanable funds and liquidity preference. It becomes pure loanable funds only in the long run, where the interest rate is determined where the IS curve crosses the long run phillips curve.

Friedman: Us monetarists were having an internal debate over hot potato money in disequilibrium here.

[Deus-DJ]

Nick, this is why post keynesians look at income, private debt, structural and institutional dynamics, and capacity utilization to determine to determine what happens next(in terms of inflation or what not), as opposed to looking at a single number, the national debt, to make that determination. It's utterly devoid of detail and is sorely lacking as any sort of indicator.

[philippe]

Nick,

The question from the MMT camp would probably be: why should the Fed's printing of money to buy government bonds in itself lead to inflation (once the economy recovers)?

The Fed's 'money printing' to buy bonds leads to huge excess reserves, but this in itself isn't necessarily inflationary (from the MMT point of view).

If we ignore the argument that low interest rates aren't in themselves inherently inflationary (debateable), the Fed can still set the interest rate at a higher level by paying interest on reserves if it wants to. The point being that it is the interest rate, rather than the quantity of reserves per se, which is (potentially) significant.

Alternatively, rather than controlling lending through the overnight rate other mechanisms could also be used. Scott Fullwiler mentioned in another post some possible alternative approaches to monetary policy:

1. Procyclical adjustments to capital requirements, which would raise costs of funding assets and be passed on to borrowers.

2. Procyclical adjustments to default risk ratings.

3. Tom Palley's asset based reserve requirements, whereby the CB adjusts the reserve requirements of banks (and others that have access to the discount window--which could be expanded for purposes here) based upon the assets they are holding. So, if the CB wants higher mortgage rates, it could institute and then increase a reserve requirement on mortgages. This effectively raises bank costs and this will be passed on to borrowers.

- All of which would ideally be combined with the sort of wholesale regulatory change to the banking system laid out by Warren Mosler http://moslereconomics.com/wp-content/pdfs/Proposals.pdf , for example.

[DaRkJaWs]

Nick, I invite you to revisit the bottleneck/structuralist theories(primarly latin american) that served as an alternative to Friedman's wrongheaded account of inflation. Look up Marcelo Diamand's paper on bottlenecks from 1977, it's a good read.

[DaRkJaWs]

Philippe,

You can't just raise "The Fed's 'money printing' to buy bonds leads to huge excess reserves, but this in itself isn't necessarily inflationary (from the MMT point of view)." This isn't necessarily the point. The point is that the government spent money into existence(remember fiscal operations are helicopter money/high powered money) while the resulting bond didn't soak up any of the resulting idle money. The result is (somehow) that private sector participants get all this high powered money, but they aren't spending it right now due to some confidence gap. Eventually they start spending when the economy recovers, and inflation results.

I think this accurately describing this mainstream position above, and if that's true then...yeah, it's pretty bad.

[philippe]

Mike Sproul,

"The fed prints $20,000 of new money. If the fed lends it to a guy who uses it to buy a car, then he has a car, the car maker has $20,000 which he uses to buy steel, etc.

If the Fed spent $20,000 digging and filling holes, then the diggers have $20,000, which they spend"

What I don't get here is why the Fed in your example can't do both - lend and spend?

Assuming the hole digger is part of a (so-called) "employed buffer stock" on a fixed wage, which acts as a flexible 'automatic stabiliser', there is no inherent reason why the Fed's 'lending' and 'spending' couldn't go hand in hand.

If the hole digger wasn't being employed, he'd still be in the public sector, so to speak, only he'd be unemployed and presumably receiving the 'fixed wage'of unemployment benefits.

Plus, as you say, the hole digger spends his money. The money circulates and those that receive it may well buy a car.

...

An added bonus of public deficit spending is that it introduces money into the economy without a concurrent private liability or debt.

This generates an increase in demand without creating an equivalent increase in financial 'leverage' or private indebtedness.

An optimal balance of public and private debts is more sustainable than simply excessive levels of private debt...
Public spending can therefore also potentially lead to a reduction in 'financial fragility', or aid in the process of deleveraging.

I'm not sure why you keep using the hole digger as an example though. I don't know of anyone who's advocating paying people to do such pointless work. As I said, it would be a waste of time and labour (unless the aim was simply to get people fit and healthy, which could be done more efficiently in other ways anyway). There are plenty of jobs which could be done that don't involve pointless tasks.

Keynes originally used that example to highlight what he saw as the absurdity of the gold standard. He suggested burying money underground and paying people to dig it up again. He was taking the mickey, whilst making a significant point.

[Mike Sproul]

Philippe:

Suppose that in addition to printing and lending $20,000, the fed also prints and spends $20,000 on holes. The fed did both, as you said. What's the result? We now have a useless hole, produced at great effort. The whole idea is to avoid producing useless holes. If the money is lent, the borrower will naturally spend it on something useful. Spending involves waste of resources while lending does not.

Keynes only advocated digging holes as being "better than nothing". My point is that digging holes is worse than nothing. The labor used to dig the holes had an alternative use, and whatever that use was is lost.

[DaRkJaWs]

Mike sproul, are you serious dude? I think you forgot to hide your ideological preferences there when you were giving your economic analysis...

[Nick Rowe]

DDJ: here's a simpler way to look at it: suppose (and that's the big debate, of course) that either monetary or fiscal policy could get us out of the recession. In a couple of years, the economy will recover, and the Bank of Canada will have inflation back at the 2% target either way. But if we use fiscal, we will have a bigger debt than if we had used monetary.

phillipe: "The question from the MMT camp would probably be: why should the Fed's printing of money to buy government bonds in itself lead to inflation (once the economy recovers)?"

Let's put it this way. 20 years ago the Bank of Canada decided to target 2% inflation. Fiscal policy was not used to keep inflation on target. Fiscal policy has changed a lot over the last 20 years. But inflation has averaged almost exactly 2%. If monetary policy alone were unable to control inflation, this would be an amazing fluke.

DarkJaws: thanks. But if I read all the 1001 things I should be reading....just not enough hours in the day.

[Kevin Donoghue]

"The labor used to dig the holes had an alternative use...."

Keynes had a rough way with objections of that sort:

"You must not press on with telephones or electricity, because this will raise the rate of interest."

"You must not hasten with roads or housing, because this will use up opportunities for employment which we may need in later years."

"You must not try to employ every one, because this will cause inflation."

"You must not invest, because how can you know that it will pay?"

"You must not do anything, because this will only mean that you can't do something else."

"Safety First! The policy of maintaining a million unemployed has now been pursued for eight years without disaster. Why risk a change?"

"We will not promise more than we can perform. We, therefore, promise nothing."

This is what we are being fed with.

They are slogans of depression and decay—the timidities and obstructions and stupidities of a sinking administrative vitality.

Negation, Restriction, Inactivity—these are the Government's watchwords. Under their leadership we have been forced to button up our waistcoats and compress our lungs. Fears and doubts and hypochondriac precautions are keeping us muffled up indoors. But we are not tottering to our graves. We are healthy children. We need the breath of life. There is nothing to be afraid of. On the contrary. The future holds in store for us far more wealth and economic freedom and possibilities of personal life than the past has ever offered.

There is no reason why we should not feel ourselves free to be bold, to be open, to experiment, to take action, to try the possibilities of things. And over against us, standing in the path, there is nothing but a few old gentlemen tightly buttoned-up in their frock coats, who only need to be treated with a little friendly disrespect and bowled over like ninepins.

Quite likely they will enjoy it themselves, when once they have got over the shock.

One of the really great rants.

[Deus-DJ]

a damn good one I might add, shit how did I miss that?

[Kristjan]

Nick, I read the link you provided: "They contrast this “more conventional view” with the “new view” that “open market operations alter the stock of money balances if, and only if, they alter the quantity of money demanded by the public."

I agree

what follows is not very logical to me. May be I am too stupid but I don't get the hot potato thing.

"The stock of currency (or the monetary base) can function as the hot potato that determines (in conjunction with all the other variables affecting the demand for currency or the monetary base) the price level."

If the CB overnight rate is close to zero, so are the treasury rates. CB buys treasuries, banks will have excess reserves and those potatos are somehow hot, the potatos they had before(treasury securities) were cold? They could always borrow against them if they needed reserves. I just don't see how you argue this Nick. You could say that lowering interest rates created more borrowing but not the quantity of reserves.

Thanks again for your reply and sorry if I didn't represent your views correctly.

[philippe]

Mike Sproul,

Agreed, if the unemployed person could be employed within the private sector (or within a 'proper' public sector job) then that would be better.

But the only reason the person would be employed on a fixed wage by the government in this way is that alternatively he/she would be languishing in unemployment, presumably still getting paid at a fixed rate by the government (unemployment benefit).

At present the standard policy is basically to have a portion of the population in unemployment, as a way of disciplining inflation. Simply flip that on its head and put the same portion of people in employment, at a fixed wage (what becomes the 'wage floor'), and you kill two birds with one stone.

You still have the inflation-controlling 'buffer' - but it is employed rather than not.

The 'automatic stabiliser'/counter-cyclical function of this 'buffer' generates additional demand in a downturn, and then shrinks as the economy recovers and people are hired back into the private sector. At the same time, the additional financial and social costs of unemployment are minimised.

What it requires is a kind of 'step up', in which the previously unemployed 'buffer' is now paid a higher (but still fixed) wage to do something useful rather than wasting away.

The fixed wage is at or below the private sector minimum.
In theory this entails a general shift upwards towards a living minimum wage over time, rather than the current situation of an 'unlivable' minimum wage regime.

There are many possible variations - the work could be full or part time and could be combined with training and all the other stuff that goes along with unemployment today (help with finding jobs etc).

But as I said, there's no point in paying people to dig holes only to fill them in again. If you are going to employ the unemployed then they should at least do something that is useful (both for them and for everyone else). This doesn't have to mean direct employment by the government. The government could simply fund the employment by private (probably non-profit) organisations. It could be scaled up over time from small initial experiments.

None of this would mean that 'the fed' couldn't ALSO lend, as it normally might. The 'employed buffer stock' is simply an 'automatic stabiliser' program in essence no different to current unemployment programs, only better and *less wasteful*.

Its potentially a solution to the problem of systemic unemployment, a way of helping to stimulate demand in bad times, and a less wasteful (less hit-and-miss) alternative to NAIRU-oriented policies.

[philippe]

Nick,

"inflation has averaged almost exactly 2%. If monetary policy alone were unable to control inflation, this would be an amazing fluke."

Agreed,

but the point I was trying to make is that the central bank can still set the interest rate and try to control inflation in that way even if the quantity of reserves is much larger than it typically has been in the past.

My understanding:

The CB's inflation control mechanism at present seems to work through the interest rate. The quantity of available reserves isn't necessarily the important thing - the two are not inherently connected when the interest paid on reserves can simply be set by the central bank at its target rate.

It's the 'price' rather than 'quantity' thing.

The reserves themselves don't leave the reserve system unless they are withdrawn as cash, and in any case the CB makes cash available if it is really needed so excess reserves don't add anything new there.

As it stands, the CB provides reserves as needed at a given 'price'. It sets the rate through OMOs, letting quantity of reserves float in response to the demand at that particular interest rate.

The quantity of reserves is not a constraint nor a stimulatory factor in itself, the important thing is the interest rate (within the current regime at least).

(There are also other possible alternative/ additional ways of controlling inflation/ conducting monetary policy, as mentioned (in part) above.)

This is all my personal understanding. Please don't consider it to be representative of anyone else's views.

Thanks for the response.

[Ramanan]

Nick,

Okay points accepted. (As in I am a huge believer in the balance of payments constraint and that its not dead horse but the most active horse and that's why Geither goes to China regularly - but anyway someday later).

The reason I linked it was that I thought - at least from my perspective - the most useful summary of what was going wrong in the period and as admitted by him, Monetarism came to popularity at the worst possible time and completely changed the policy discussions and focus in the wrong way.

That's a story I attempt to tell to various people on blogs - including "heteredox" economists.

But thanks you actually read it. I will anyway send you the scans since Google Books doesn't show up all the pages (for the sake of completeness - not for anything important you may have missed - which you may not have.)

[philippe]

Nick,

I think the argument made by Mosler et al is not that interest rate setting can't be used to control inflation, but rather that it's not really the best way to do it - and that it doesn't always deliver the intended result (or even if it does it only does so in an inefficient way).

So, for example, low interest rates can potentially depress demand because they remove income from the economy, and high interest rates can paradoxically stimulate demand because they increase interest income. Super high rates succeed in crushing inflation but only by simultaneously crushing the economy.

It probably has a lot to do with distribution of income and the current situation regarding private debt at any given point in time. A bit beyond me, really. But the thing I take away from it is that monetary policy in its current form is seen to be a blunt instrument, and other ways of achieving similar outcomes vis a vis inflation would be better and less distortionary or disruptive.

The 'natural rate of interest is zero' thing is a bit tongue in cheek, in the sense that they don't seem to believe in the natural equilibrium rate in the mainstream sense.

Instead, in the absense of additional actions by either the treasury or the CB to support the interest rate through either bond issuance or IOR, the interest rate 'naturally' falls to zero when the government deficit spends, which in a fiat money system it has to do to provide currency to the economy with which the taxes imposed can be paid.

The point being that the government necessarily has to spend before it can tax or borrow in the currency which it alone issues (bank credit not being government currency).

Any additional actions (bond issuance to 'drain reserves' or IOR are *additional* interest rate maintenance measures - policy choices and neither inherently necessary or 'natural'.

Ramanan - you know about these things. Am I giving a fair description here or not?

[Mike Sproul]

Darkjaws:

Ideological? You are misinformed. People who disagree with me are ideological; unless they disagree a lot, in which case they are crackpots.

[Mike Sproul]

Philippe:

Sorry, but there's just too much to disagree with in your post, so that I don't know where to begin. This is why I usually restrict my comments to issues relating to the backing theory of money, where I have a comparative advantage. There are thousands of economists who are well-equipped to address what Frank Knight called the "notorious fallacies" of Keynesianism.

[philippe]

Mike Sproul,

Fair enough, I get that you're in a totally different mindset/paradigm.

If the basis of your objestions is that Keynesianism is a load of balls then that's kind of the end of the debate I guess, for now.

I suppose these things ultimately have to work themselves out through the democratic process. Two wolves and and lamb deciding what to have for dinner...

[DaRkJaWs]

I note the sarcasm but still, making statements like "Spending involves waste of resources while lending does not" is purely political, if you're going to make such a statement don't dress it as some economic argument. Now that's not to say that all economic arguments have a political basis, but we admit it...you on the other hand, i'm not so sure.

[philippe]

Although it would be interesting and useful for me to know more about what your objections are, as a wolf determined to devour the poor little gold standard lamb along with my fellow raving statists (!).

[philippe]

DarkJaws:

"The point is that the government spent money into existence(remember fiscal operations are helicopter money/high powered money) while the resulting bond didn't soak up any of the resulting idle money."

That's not really how it works, as far as I can see.

My understanding (simplified):

When the government deficit spends and issues bonds, the quantity of deposit money in the economy increases, but the quantity of reserves remains the same. If the government deficit spends without issuing bonds, the quantity of deposit money in the economy increases and the quantity of reserves increases. Understanding the difference and relationship between deposits and reserves is crucial.

Increased reserves lead to a lower interest rate unless the Fed sells govt bonds (which it had previously purchased) or pays interest on reserves (with newly created reserves). Lower interest rates may be stimulatory or they may not, there's some disagreement about this. But increased levels of reserves are not necessarily more inflationary than unchanged levels of reserves if the interest rate remains the same in both cases (which is possible with interest paid on reserves).

Super Simplified example:

Lets say you deposit $100 in a bank.

The bank credits your account with $100.

You now have $100 credit (i.e. $100 deposit money) and the bank has $100 reserves.

The bank keeps $10 reserves and uses $90 reserves to purchase a government bond.

The $90 reserves are taken by the treasury. You still have $100 credit in your account, the bank now has $10 reserves and a $90 bond.

The treasury then spends the $90 reserves it borrowed from the bank to pay Mr B, who has an account at that same bank (for simplicity).

The bank receives the $90 reserves and credits Mr B's account with $90.

The bank now has $100 reserves as well as the $90 bond. You have $100 credit (deposit money) in your account and Mr B has $90 credit (deposit money) in his account.

Overall, at the end of this process, bank reserves are the same quantity as they were before, but now the bank has a bond worth $90 and $90 of new deposit money has been added to the economy.

The bank can now use the reserves it has in excess of its reserve requirement to 'invest' in something else.

Please Correct.

Resp,

[Ramanan]

"Ramanan - you know about these things. Am I giving a fair description here or not?"

Philippe,

Haven't followed your discussion but here's a take on your last comment. I see the MMTers say often certain things about interest rates and I simply do not agree with the way it is presented.

This is assuming business investment has no interest elasticity. Low interest rates can have stimulatory effect on demand - especially residential investments. Since purchases of residential apartments itself adds to demand and even if business investment has low interest elasticity, the demand created by residential investment can stimulate business investment.

Monetary policy does have an effect. I understand fiscal policy is very powerful but that shouldn't be highlighted by giving zero role to monetary policy.

[Nick Rowe]

Ramanan @02.20am = sensible Post Keynesian.

philippe: "So, for example, low interest rates can potentially depress demand because they remove income from the economy, and high interest rates can paradoxically stimulate demand because they increase interest income."

Price (including interest rate) changes have: income effects; substitution effects. Your analysis looks only at income effects and ignores substitution effects.

philippe: "This is all my personal understanding. Please don't consider it to be representative of anyone else's views."

Your views there are (roughly) representative of the large majority of mainstream macroeconomists. New keynesians would say (roughly) the same thing. But:

1. Some would say that's not the only way of looking at it, or doing monetary policy.

2. All (most) would say that what you have just described, where you treat the central bank's interest rate target as the exogenous variable, is correct only for the very short run (about 6 weeks in Canada). In the longer run, the Bank of Canada targets inflation, not interest rates, so the interest rate becomes endogenous. Again, see my recent posts here and here.

I gotta grade exams.

[Nick Rowe]

Kristjan: "May be I am too stupid but I don't get the hot potato thing."

Most very smart economists, including some of my fellow-monetarists, don't get the hot potato thing either. They can't handle disequilibrium analysis ;-) I'm the heterodox one!

Try my old post here.

[philippe]

Ramanan:

"Monetary policy does have an effect. I understand fiscal policy is very powerful but that shouldn't be highlighted by giving zero role to monetary policy."

I agree with you actually. There seems to be abit of disagreement among MMT people about this. Bill Mitchell seems to be more of a 'fiscal policy puritan'. But I asked Scott Fullwiler about this and he said the following:

Some potential alternative approaches to monetary policy:

"1. Procyclical adjustments to capital requirements, which would raise costs of funding assets and be passed on to borrowers.

2. Procyclical adjustments to default risk ratings.

3. Tom Palley's asset based reserve requirements.

"None of these really matter or would be all that effective without wholesale regulatory change, and that's why one sees a lot more focus on that from MMT'ers rather than alternative approaches to monetary policy. But that doesn't mean we are against using monetary policy per se.

"Remember, ZIRP only applies to the overnight, risk-free rate. Other rates are going to be higher. And with no manipulation of short-term nominal rate, longer-term rates would be less inclined to have negative holding period returns. On average, those returns might be about the same but with less risk."

'''

You also have Rodger Mitchell who advocates a kind of MMT in which monetary policy plays the same role/ is done in more or less the same way as it is at present.
This could either be through the usual system of bond issuance and OMOs, etc, or by taking the approach of paying interest on reserves and setting rates that way.

[Nick Rowe]

philippe and Ramanan: BTW, income effects don't really exist.

[DaRkJaWs]

Phillipe: I didn't get a chance to go over your post fully, but thanks for clearing up any confusion I may have.

Nick: Income effects don't exist? be sure not to say that in a room full of post keynesians. In fact, they argue that substitution effects are so negligible that they don't exist. There is a paper by Lavoie that goes over this.

[DaRkJaWs]

Hell, you're in Ottawa too, why don't you go across the street and have a friendly discussion about this with Dr. Lavoie?

[Nick Rowe]

DarkJaws: Funny you say that. I first said it about 15 years ago while lunching with Marc Lavoie! His eyebrows did shoot up, IIRC! So I explained why I believed it. It follows from getting the accounting right. For every x apples bought there must be x apples sold. For every one dollar borrowed there must be one dollar lent. (There may still be distribution effects, of course.)

[Nick Rowe]

I know Marc's a smart economist, BTW, and I'm pretty sure he understood my argument. Though whether or not I convinced him, I dunno. Maybe not.

[K]

Nick: "There may still be distribution effects, of course."

Yeah, but whatever. IIRC, all agents have about the same amount of money. :-)