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Nick,

The question of whether 'income effects don't really exist' is probably a bit 'above my pay scale' at present. As you say such questions are perplexing for non-economists. However, the fact that Prof Lavoie disagrees with you on this one makes me think that the issue might not be so cut-and-dry.

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

Absolutely correct. However it wasn't really my analysis. I was simply giving an inadequate account of someone else's ideas. Yes, I completely didn't mention the other side of the equation.

Warren Mosler talks a bit about his views on this subject (in relation to low interest rates) here, if you're interested: http://www.cnbc.com/id/46115110

not only the distributional effects, but even ignoring that and accepting your argument income effects exist! the sectoral balances Lavoie and Godley are famous for! not to mention the problem between ex ante and ex post. you are correct that ex post, items bought equals item sold, but ex ante items for sale and quantity of items desired for purchase (at roughly the prices the good has cost in the past) is almost never equal. I think that accounting argument is quite weak.

On this same topic, a lowering in the interbank market lending rate lowers the net interest payments, which is a concrete income effect that isn't effected at all by your argument. the rentiers earn less and borrowers owe less part is obviously dependent on the relative effects on each groups, but i tend to think the net effect wouldn't swing much either way. Following Keynes, Harrod and Shackle (the Oxford Economists Research Group and many others) I tend to think that investment is pretty insensitive to interest rate changes and are swamped most of the time by uncertainty (as Ramanan points out, it depends on the industry but I'm still less sanguine then him). A semi-permanent targeting of the long (or at least a longer) term rate of interest would be much more effective but still not very effective in my view (the fed went for quantity, not price which means qe is less effective then it could have been. not to mention all the money that shifted into commodities to find a decent rate of return).

Nathan: "you are correct that ex post, items bought equals item sold, but ex ante items for sale and quantity of items desired for purchase (at roughly the prices the good has cost in the past) is almost never equal. I think that accounting argument is quite weak."

Good point. I tried to explore that point in this old post.

@Nick: good post. One point, In the real world I think a firm is more likely to accumulate inventory initially or try some kind of ad campaign before lowering prices. lowering prices is a little bit more of a last resort kind of thing. Similarly, I think that a store that notices an item is selling above trend will most likely order more from their supplier rather then trying to raise prices to ration demand. The alienated costumer costs and medium to long term loss in market share through competition costs.

philippe @ April 17, 2012 at 08:57 AM,

It is difficult to resist a tool when you have it. I am a bit against following any method for monetary policy - these change as central bankers learn more and more. For example, if you read the Bank of England reports (such as inflation/FS/Quarterly - all nicely written), it had resisted attempts to increase interest rates recently simply because it would increase the debt burden of households' debt whose liabilities are strongly interest sensitive.

I haven't read Rodger Mitchell because I get put off by the usage of sovereignty in every statement :). Nothing against it but the concept is more deeper than what he or others tend to use.


Nathan: Thanks. That's an argument about sticky prices. I agree that prices are sticky. I don't understand why. But let's leave that.

You (@07.18) are an "elasticity pessimist", like many Old Keynesians, who thought the IS curve was fairly steep. OK. But is monetary policy even really about interest rates at all? Consider this weird thought experiment.

Yeah except that I don't think the ISLM model makes much sense at all. I hate talking in those terms.

As you know, I think monetary policy is really a misnomer and it really is interest rate policy. I don't accept the natural rate, so I don't see the cumulative process the neo-wicksellians do.

"the concept is deeper than what he or others tend to use"

I'm waiting with bated breath for your revolutionary magnum opus, Ramanan. Agreed, many things are (possibly) lacking in the mmt/ms literature. Up to you and others then to place something interesting within those gaps I guess..

Sovereignty. Hmmm, yes, it can be quite an irritating word. Especially when it becomes a one-man-brand. Still, combining MMT-style fiscal/regulatory approaches with different monetary policy approaches could be a decent way forward. The puritans won't be happy though. Nick is probably laughing at the ridiculousness and futility of it all as he reads this. Inflation, inflation... will you never learn?

"Monetary sovereignty" is just another word for "you are free to choose your own monetary target who will rule over you".

Nathan: "As you know, I think monetary policy is really a misnomer and it really is interest rate policy."

here's an alternative perspective.

When we said Orthodox economists should delve more into other social sciences that's not what we meant!

reminds me of the famous Milton Friedman quote justifying ignoring empirical research on price setting... i mean unrealistic assumptions in modelling.

"Let the apparent immediate determinant of business behaviour be anything at all—habitual reaction, random chance, or whatnot. Whenever this determinant happens to lead to behaviour consistent with rational and informed maximization of returns, the business will prosper and acquire resources with which to expand; whenever it does not, the business will tend to lose resources and can be kept in existence only by the addition of resources from outside"

Suppose a Marxian anthropologist were analysing the sale of indulgencies (or gifts to the priest). Would he take the religious explanation given by the practitioners at face value? Should I take as authoritative central bankers' own conceptual scheme for describing their own behaviour? Sometimes I want to swallow the other pill, and see what the world looks like from that perspective. You Post Keynesians (and Neo Wicksellians generally) are far too credulous when it comes to central banking. You have swallowed whole the prevailing ideology of the central bankers themselves ;-)

"reification", that's the word I think I want. You have reified a mere communications strategy.

"Monetary sovereignty" is just another word for "you are free to choose your own monetary target who will rule over you".

Preferable to being ruled by the bond market.

Self-imposed rules have the added benefit of being flexible. If the Bank of England misses it's 2% inflation target (which it has done consistently for years) the governor has to write a letter to the chancellor explaining why. He doesn't have to sack all his staff and sell off the nation's public assets.

If a non-'monetarily sovereign' country misses a bond payment its entire economy implodes.

"I'm waiting with bated breath for your revolutionary magnum opus, Ramanan"

:). He he.

philippe,

There are degrees of sovereignty. Monetary sovereignty - if that is defined as the power of the government to use the overdraft facility at the central bank, if an extreme emergency arises is what it is. So the EA17 governments gave up their sovereignty the day they adopted the Euro. (Some economists such as Nicholas Kaldor used the phrase "constitutional monarch" to describe the power of the central bank instead of sovereignty).

However when a nation starts interacting with the external world, there are other aspects of sovereignty which are given up partly. Such as the ability to protect industries against foreign competition and to managed international trade.

See this 1991 article by Anthony Thirwall here referenced by Martin Wolf http://blogs.ft.com/martin-wolf-exchange/2012/02/16/can-one-have-balance-of-payments-crises-in-a-currency-union/ (from the end of column 3).

Hey Nick, related but mostly off topic, I've been trying to find an opportune moment to ask:

If government debt will eventually impose a burden on future cohorts (with all the restrictions on that statement previously imposed), is that also true of private debt? Why or why not?

U.S. private debt/GDP hit 350% just before the crisis, dwarfing government debt...

I'm thinking a post on this could stimulate some darned interesting discussion.

Ramanan:

In the US and UK the central banks are part of the government in the wider sense - the term 'government' doesn't just refer to parliament or congress. The Fed is an independent agency of the federal government and constitutionally part of the executive branch, whilst the Bank of England is wholly owned by the Treasury. I don't know what the situation is in Canada.

US and UK treasuries don't have access to the CB overdraft facility under current arrangements, though as you say they probably would in an extreme national emergency (unless that emergency was hyperinflation).

I don't know about the UK parliament, but congress is actually technically able to issue its own money directly if it wants to, even under current arrangements.

Of course both countries could remove any barriers between their central bank and treasury if they really wanted to. The current seperation seems a bit illusory anyway, given that normally the CB just accomodates treasury spending as part of its control of the interbank interest rate and its attempt to meet the target(s) of low inflation and steady growth. In the absense of gross mismanagement by the treasury there's no reason the two bodies should be at odds in any way.

The Bank of England isn't going to start holding parliament to ransom, for example, as the ECB is currently doing to Greece. I don't even know if the BoE actually could, if the will of parliament was against it.

Despite the fact that under current arrangements treasury and CB are seperate, it's still technically and realistically accurate to describe countries like the UK and US as having 'monetary sovereignty' - with that sovereignty placed within the government in general, whose will is ultimately determined by the executive body (parliament, congress etc).

Being a sovereign currency-issuer doesn't make you impervious to reality though. Having your own currency doesn't mean you can just do whatever the hell you want.

As you say, there are many things that are out of a sovereign state's control. And the government is of course always constrained, thankfully, by at the very least the 'will of the people' and the rule of law. It is also constrained by all sorts of other factors, many of which are self-imposed.

By its own actions the government can effectively destroy its own sovereignty. External forces can also oblige it to act in certain ways. But nonetheless as a currency issuer it has a extensive range of choices open to it that don't exist for currency using states such as those in the Eurozone at present.

The fundamental limit to 'monetary sovereignty' is, I think, inflation (assuming the government is commited to economic growth and maximum employment) - though even this constraint is highly flexible in reality.

A 'currency crisis' in the usual sense is something that is more likely to happen in a fixed exchange rate system. The possibility of something like this happening (either suddenly or over time) to a sovereign currency in a floating rate system is something I'm really interested in and and still unsure about. This relates of course to the sustainability of persistent large trade deficits and the MMT view that they're not *necessarily* a problem. What are your thoughts on this issue, Ramanan?

Two 'ands' for the price of one, bargain.

Steve: "If government debt will eventually impose a burden on future cohorts (with all the restrictions on that statement previously imposed), is that also true of private debt? Why or why not?"

This got discussed (somewhere) in that (massive) thread of comments on one of my (many) "burden of the debt" posts.

Trying to remember my answer. If I die and bequeath my house to my kids, they will be $100,000 poorer if I bequeath them the (same) house plus a $100,000 debt. But, I cannot bequeath my kids a $100,000 debt and no house (or other assets). My kids will just refuse to accept the negative bequest. In the olden days (I think it was Determinant who told me this useful nugget) it was possible to leave negative bequests to your kids. Your kids had to pay your debts.

I just started reading the Fluttering Veil. Only 15 pages in and I know these are the cliff notes to Nick Rowe's brain.

philippe,

Inflation has nothing much to do with sovereignty.

I guess the point I was trying to say is that signing agreements on free trade concedes some amount of sovereignty - a lot actually IMO. Although I thought you didn't appreciate my point.

About trade deficits, I have had discussions with the Chartalists - some of which have had the most acerbic language - from both sides!

On a related note, the best book about debates in the UK and the transition from Keynesianism to Monetarism is a book called From Keynesianism to Monetarism: The Evolution of UK Macroeconometric Models - written in 1994 and republished in 2011.

http://books.google.co.in/books/about/From_Keynesianism_to_Monetarism_Routledg.html?id=zePAbwAACAAJ&redir_esc=y

I like the economic debates of those times - because I think it is the most relevant to 2012 and beyond.

Ramanan:

"Inflation has nothing much to do with sovereignty"

Inflation is the basic constraint to government deficit spending, isn't it? That's all I meant by that.

@philippe: nooooooooooo! save yourself Philippe! the balance of payments constraint arguments are coming!

NCT,

"@philippe: nooooooooooo! save yourself Philippe! the balance of payments constraint arguments are coming!"

Don't worry they are not! Notice I resisted in spite of philippe's asking.

philippe,


""Inflation has nothing much to do with sovereignty"

Inflation is the basic constraint to government deficit spending, isn't it? That's all I meant by that."

Since when is sovereignty = deficit spending?

@Ramanan: haha fair enough. You know i couldn't resist the perfect moment to joke.

I think you're probably right about the balance of payments constraint. But that's not disimilar to an inflation constraint, is it? A balance of payments/ currency crisis entails sharp falls in the exchange rate and hence higher prices on imports, and then on everything else? i.e. rampant inflation? Currency crisis/ inflation = government losing the ability to issue money with actual value.

Ramanan: If a government can't deficit spend for some reason, they're not really 'monetarily sovereign', are they? This might be due to being unable to borrow, like Greece, or being unable to issue a currency with any value, due to hyperinflation. The government can get its sovereignty back, by leaving the eurozone for example, or by establishing a new currency (if they're actually able to), but until that happens they're screwed. Mugabe throwing trillions of worthless Zimbabwe dollars around is 'monetarily impotent'.

philippe: "I think you're probably right about the balance of payments constraint. But that's not disimilar to an inflation constraint, is it?"

You are on the right track, but one shouldn't push the similarity too far. Here are two examples where they are different:

1. Suppose all the other countries in the world have deflation and recession. If you have a fixed exchange rate, you may (and probably will) suffer the same fate. An inflation target lets you allow the exchange rate to depreciate, and lets you escape. 1930's was an example of this. When each country, one after the other, left the gold standard, they started to recover.

2. There are times when there's a fall in demand for your country's goods, while other countries are doing OK. It's much better to let your exchange rate fall than to suffer deflation.

Put it another way: if you lived in a country where gold mining was by far the biggest industry, and where people spent most of their income on bling, the gold standard would be a reasonably good monetary policy. There is no fundamental difference between the gold standard and inflation targeting. It's just that gold is terribly unrepresentative of the goods most of us produce and consume.

And MMTers need to face this problem.

@ Nick: your argument about the gold standard not being a problem in countries with big gold mining industries is straight out of the General Theory. It was his whole point with the burying money that private industry would dig out example.

"Put it another way: if you lived in a country where gold mining was by far the biggest industry, and where people spent most of their income on bling, the gold standard would be a reasonably good monetary policy."

For the government to have a monetary policy in this situation it would probably have to seize control of the gold supply in some way, assuming it wanted to use gold as the monetary unit of account rather than simply encouraging its production as a commodity for sale on the open market.

Just because a country is rich in gold mines doesn't mean that gold should serve as the basis of its monetary system. Money is an abstract system of credits and debits - whether the records are printed on gold or clay or paper is not necessarily that important. It comes down to whether the monetary authority is trustworthy or not, and whether it has the power to assert its authority.

"There is no fundamental difference between the gold standard and inflation targeting"

Really doubtful. I need more info on this before I can accept the hypothesis.

Gold standard is a fixed exchange rate system with a more or less arbitrary money supply, whereas inflation targeting is a floating exchange rate system with a money supply determined by the aims of the money-issuing body. Is there really no difference between the two?

Sorry, went off on one there. No delete button. Pretentiousness out there for all to see. oh well

Nathan: OK. BTW, I don't know if you ever saw my earlier take on that same paper gold mining/JG metaphor.

philippe: nothing obviously daft or pretentious in your comment. It's a blog comment, in any case.

Gold standard fixes the price of one good -- gold. Inflation targeting fixes the price (path) of the CPI basket of many goods. If two countries had the same CPI basket, and if all goods in that CPI basket were easily tradeable (low transport costs), then inflation targeting by two countries would imply fixed exchange rates between them.

Central banks on the gold standard didn't own gold mines. Central banks on the CPI standard don't own CPI basket factories.

"Central banks on the gold standard didn't own gold mines"

That's one of the things that was daft about my comment.

The vague idea was that for the government to pursue monetary 'policy' as such would require that it have control. The government effectively gains control of the gold by holding most of it in its vaults. It gets the gold straight from the mines by issuing paper notes and ensuring that its currency is the dominant currency in circulation. It can raise interest rates to stop outflow from its vaults, but when this doesn't work anymore it can just stop the outflow by closing the vault door.

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