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I can't buy this, Nick. It seems like the old "shortage of money" account of economic destitution - which I think Hume effectively refuted way back in "Of Money".

Broad money is generated endogenously within the economy, as needed, in response to opportunity. If an entrepreneur has an opportunity to turn some real resources into something of greater value, and make a profit from the sale of what is created, and he makes a convincing case that he can do so to a banker, then the banker will supply the money the entrepreneur needs on the spot in return for interest in the profits. If bankers do not want to to this, its not because to many people are hoarding the money that already exists - since they don't need the money that already exists - it's because the entrepreneur can't make a convincing case that he will profit. And the reason he can't make a convincing case that he will profit. And he can't make such a case if his customers are impoverished.

Leave out my second-to-last sentence.

Hume was wrong. A banker, or any other business person, can shift from "profit-maximization" mode, where increased profit equals increased risk, to "balance-sheet preservation" mode where additional risk is unwelcome as it would injure the balance sheet and imperil the firm.

In the first case the income statement is more important than the balance sheet, in the second the balance sheet trumps the income statement.

You can't talk to a banker about risk who can't look past his balance sheet, he's not crazy, just on a different page. His needs and your needs no longer coincide and it has nothing to do with you.

Dan: seriously. Re-read Hume. Of Money. The reason why Hume thought a halving of the stock of money wouldn't matter is because he thought that, in the long run a halving of the stock of money would cause a halving of the price level. Then read that bit about how a change in the amount of money does matter in the interim between the increase in the stock of money and the increase in prices, where even the ploughman follows his plough with greater diligence, and how it is the good policy of the magistrate to keep the stock of money increasing (Hume loses it a bit here). It is in the open economy version, Of the Balance of Trade, where Hume invokes the price-specie flow mechanism to say that the stock of money is endogenous (to an individual country on the gold standard).

Hume:

"If we consider any one kingdom by itself, it is
evident, that the greater or less plenty of money is of no
consequence; since the prices of commodities are always proportioned
to the plenty of money, and a crown in HARRY VII's time served the
same purpose as a pound does at present."

A clear statement of the Quantity Theory of Money and the (long run) neutrality of money.

"But notwithstanding this conclusion,
which must be allowed just, it is certain, that, since the discovery
of the mines in AMERICA, industry has encreased in all the nations of
EUROPE, except in the possessors of those mines; and this may justly
be ascribed, amongst other reasons, to the encrease of gold and
silver. Accordingly we find, that, in every kingdom, into which money
begins to flow in greater abundance than formerly, every thing takes a
new face: labour and industry gain life; the merchant becomes more
enterprising, the manufacturer more diligent and skilful, and even the
farmer follows his plough with greater alacrity and attention....."

A clear statement of the empirical short run non-neutrality of money.

"To account, then, for this phenomenon, we must consider, that
though the high price of commodities be a necessary consequence of the
encrease of gold and silver, yet it follows not immediately upon that
encrease; but some time is required before the money circulates
through the whole state, and makes its effect be felt on all ranks of
people."

A clear statement of the reason for that short run non-neutrality: it takes time for prices to adjust.

"Broad money is generated endogenously within the economy, as needed, in response to opportunity."

A fascinating assertion, since it implies (1) no monetary disequilibrium; (2) no central bank or base money (assuming you're defining, dubiously, 'the economy' as the non-government economy); and (3) the absence of any relation between central bank activites, asset prices and "opportunities".

Apart from that, it's on the right lines.

BTW: when Hume says

"It is only the public which
draws any advantage from the greater plenty of money; and that only in
its wars and negociations with foreign states."

By "the public" he means "the government". A country with a large stock of gold, and high prices, relative to other countries, will be able to fight wars overseas and bribe foreign governments more cheaply.

Nick, I'm not talking about the part of Hume's essay where he talks about what would now be called the short-run non-neutrality of money. I'm talking about the later section in which he discusses the supposed problem of shortages of money, particarly with respect to agricultural regions. He argues that the whole idea of a shortage of money is a mis-diagnosis of the phenomenon of economicunderdevelopment.

But in our time,with metallic money or standards playing no real role, and having adopted the paper credit money that Hume deplored, the whole idea of a shortage of money as the source of economic underperformance makes even less sense. The central bank has adopted a wildly accommodative stance with respect to the supply of reserved which are the modern day "gold" upon which bank credit is written. This base money can be manufactured at will and is available to banks at a fraction above 0%! Any borrower who can make the case that he has an enterprise that will not lose money can get this money at a song. There is no shortage of money or tight money or cold potato money. It's not about money! It's about real resources and goods and their distribution. The capitalists have impoverished the human foundation of the economy and indentured them to the owners of property. No wonder they can no longer support the level of demand needed to produce growth.

Since the economy cannot strongly support the injection of purchasing power in the form of credit - because of a shortage not of money, but of credit-worthiness - then the only way to inject purchasing power into the economy is to force feed it in by direct government action. There is no money-master in our world. The central banker can't push money out into the economy via the money multiplier that doesn't exist. If there is insufficient credit worthiness at the zero bound, then the central banker can't manufacture it. There is no monetary hot potato - the very idea is ludicrous. And the central banker is also not some kind of national party master or expectations Svengali that can stoke or hypnotize people into spending - especially spending resources they don't have.

For people who are so convinced that the key to the problem is money, you monetarists are remarkably reticent about advocating the steps that could actually work to inject money directly into the sick economy: having the people's representatives vote to use their inherent monetary authority to spend money directly into the economy, including by hiring some of the millions of unemployed to do some of the millions of public services we need done that are not getting done. Why not? Is it that you take your marching orders from Scott Summer who is a stubborn right Wong ideologue who hates democracy and is terrified by the idea of the people taking control of their own economy and wresting it from impotent central bankers and their authoritarian fan clubs of economists who dream of controing the world from a single panel led office?

I'm a little weary of the constipated kvetching of the NGDP club. Too me you guys are starting to seem like a bunch of guys locked in a bathroom and railing at the world over the tightness of your own sphincters. Open the door and step outside. There is a lot more broken out here than the brainwave machine connecting our minds to the alpha waves of Ben Bernanke.

Now I think I'll go home and have a laugh with my wife about the fact that there are these guys out in the blogosphere who think the reason we have not bought much stuff lately is that we have suddenly developed a strange desire to "hold" too much money. My co-workers will also get a kick out of the idea that that is why we didn't get raises this year. My company sells books. And you know what. I think if we were paid in books, we wouldn't have gotten more of them this year either.

Dan Kervick,

Would you agree then that the time has come to buy up and retire the US national debt? People are indifferent between government bonds and base money right now, so it won't make any difference except to make future debt expansion easier and to eliminate any remaining interest payments by the US government.

Sorry about all the typos. I typed the above on my iPhone where I'm even worse than usual.

W. Peden,

So that would amount to a kind of quantitative super-easing, right, with years of interest payments scrunched up into the immediate term? Couldn't that cause more of the asset-market distortions that (I think) we have already?

How about if we just transferred the obligation to pay the debt to the Fed, which they can then do on the existing schedule, by marking up bank accounts as needed, without collecting a dime of taxes or borrowing any additional funds?

“It is a cliche (among economists) to say that expectations matter.” – (Nick’s opening sentence).

Quite right: I suspect there is more cliché here than empirical evidence.

Expectations are doubtless important in some cases. For example as W.Peden pointed out a few days ago, union leaders think carefully about future inflation when framing wage demands.

But there are other instances where economists assume expectations are important where I have big doubts. For example, it is often assumed that given rising government debt, households will assume that means future tax increases so as to repay the debt. Thus households will allegedly rein in spending given rising government debt.

I doubt it. But empirical evidence beats everything else. I’ll be persuaded when I see the evidence.

"
Broad money is generated endogenously within the economy, as needed, in response to opportunity."

A fascinating assertion, since it implies (1) no monetary disequilibrium; (2) no central bank or base money (assuming you're defining, dubiously, 'the economy' as the non-government economy); and (3) the absence of any relation between central bank activities, asset prices and "opportunities".

Apart from that, it's on the right lines."

These aren't contradictory. Interest rates and availability of risk-free collateral (for repos) and cost of funds (for banks) affect these "opportunities", and the Fed strongly influences these.

Anybody can create money. It's finding people who'll accept it that's hard. Linden dollars are money, and they can only be used inside Second Life. Still, if you search you'll find quotes for conversion to and from dollars. There are people make a living earning Linden dollars inside Second Life. There's also whole industry in China of people playing computer games to get game money and weapons to exchange for dollars.

A fascinating assertion, since it implies (1) no monetary disequilibrium; (2) no central bank or base money (assuming you're defining, dubiously, 'the economy' as the non-government economy); and (3) the absence of any relation between central bank activites, asset prices and "opportunities".

I'm not denying the existence of base money, but just claiming that loans create deposits, and deposits create reserves. The central bank influences the pace of creation somewhat by targeting an interest rate. But when interest rates are already near zero, I don't think you can make much sense out of the idea that continuing unemployment and underproduction are due to monetary phenomena, since genuine opportunity will call into existence its own financing.

Peter N,

"Interest rates and availability of risk-free collateral (for repos) and cost of funds (for banks) affect these "opportunities", and the Fed strongly influences these."

But I thought that the money was provided as needed?

"Anybody can create money."

If you mean anyone can get a line of credit, then no. If you mean anyone can create a deposit, then no.

Dan Kervick,

"So that would amount to a kind of quantitative super-easing, right, with years of interest payments scrunched up into the immediate term? Couldn't that cause more of the asset-market distortions that (I think) we have already?"

Elaborate on "distortions", please. How can swapping one asset for another change anything?

"How about if we just transferred the obligation to pay the debt to the Fed, which they can then do on the existing schedule, by marking up bank accounts as needed, without collecting a dime of taxes or borrowing any additional funds?"

Just eliminate the debt. Then there will be no case that fiscal hawks can mount against increased spending: the public debt-to-GDP ratio will be 0%, which is as good a place to increase spending as any.

"I'm not denying the existence of base money, but just claiming that loans create deposits, and deposits create reserves."

I think the word 'create' is being put to a bit of creative use here. "Loans create deposits" is a vague way of saying that commercial banks buy assets (which can be equity or can be bonds, so talking about "loans" is somewhat descriptively incomplete) through creating deposits. OK, though "Banks create deposits" is much more to the point and doesn't suggest a pseudo-causal story.

However, "Deposits create reserves" is entirely too sloppy. A deposit is a claim on reserves. For that claim to be met, the reserves have to be obtained at a price. Now, I know that you know this, but now you know that I know this, so now we both know that we both know this, we can actually get into the real points of the matter, like monetary disequilibrium and asset prices.

"But when interest rates are already near zero, I don't think you can make much sense out of the idea that continuing unemployment and underproduction are due to monetary phenomena, since genuine opportunity will call into existence its own financing."

Go back to the scenario where the entire US public debt has been bought by the central bank. I assume that people hold bonds because there is a demand for bonds. I assume that, if the supply of X goes down and the demand for X stays the same, then the price of X rises. Call it a "market distortion" or even a "price mechanism" or even "a market". Are we together this far or have I made some unwarranted assumptions?

Elaborate on "distortions", please. How can swapping one asset for another change anything?

Possibly not that much. If you buy an asset with cash that was due to deliver interest payments on a fixed schedule over several years, then in principle the seller is now more liquid and will look for something to do with that cash - like speculate in commodities. But if the two assets are of roughly equal present value, and the interest-bearing asset was already very liquid, then perhaps it really doesn't matter much.

"Loans create deposits" is a vague way of saying that commercial banks buy assets (which can be equity or can be bonds, so talking about "loans" is somewhat descriptively incomplete) through creating deposits.

I'm talking about the fact that the loans banks make to their customers create deposits. Customer comes in, asks for a loan. If the bank decides the loan will be profitable, then bang, they create an account for the borrower and credit it with a balance. They don't have to acquire funding first. If they subsequently need to acquire additional reserves, they do so.

Go back to the scenario where the entire US public debt has been bought by the central bank. I assume that people hold bonds because there is a demand for bonds. I assume that, if the supply of X goes down and the demand for X stays the same, then the price of X rises.

That seems right to me. What do you conclude form this?

Dan Kervick,

"Possibly not that much. If you buy an asset with cash that was due to deliver interest payments on a fixed schedule over several years, then in principle the seller is now more liquid and will look for something to do with that cash - like speculate in commodities. But if the two assets are of roughly equal present value, and the interest-bearing asset was already very liquid, then perhaps it really doesn't matter much."

Like I said- we can eliminate the whole US national debt tomorrow by simply swapping it for base money. It's a scandal that we've had so many zero-rate enviromments in recent years and not one country has taken this small harmless step.

"I'm talking about the fact that the loans banks make to their customers create deposits. Customer comes in, asks for a loan. If the bank decides the loan will be profitable, then bang, they create an account for the borrower and credit it with a balance. They don't have to acquire funding first. If they subsequently need to acquire additional reserves, they do so."

The way you put it there, I would be more inclined to say "Customers and banks make deposits when they agree on loans". Which is true. (Deposits are also created when banks use them to buy corporate or government bonds.)

Anyway, like I said, you know this and I know this and you know that I know that we both know this. It isn't where we disagree.

"That seems right to me. What do you conclude form this?"

So let's go to step 2: banks are in the business of acquiring assets. Go back to the bank customer: banks need to take into account both (1) what kind of profit they will get by lending at a given set of terms and (2) the credit-risk of that customer. If we think about the effects of asset prices on (1) and (2), we can see that expected higher asset prices make it more profitable to invest in assets, while customers who can offer higher-priced assets as collateral are less risky to lend to. Additionally, remember the role of the customer in the process: people will be more willing to buy a house, for instance, if they expect the value of that house to increase strongly.

Given that we know that banks lend to creditworthy customers* (where potential returns are thought to be greater than expected risk of default) and given that assets prices have an unbounded effect on (1) and (2), what should we expect to occur if the price of interest-bearing assets is increased by a reduction in their quantity?

* Here "customers" includes sellers of bonds as well as people getting out loans, because it's always worthwhile avoiding thinking just in terms of either businesses or households or the government; all three can obtain credit from banks.

Dan: Hume is there talking about barter and peasants who grew their own). And princes collecting taxes in kind too. (Obviously he hadn't read Graeber):

"There are some
kingdoms, and many provinces in EUROPE, (and all of them were once in
the same condition) where money is so scarce, that the landlord can
get none at all from his tenants; but is obliged to take his rent in
kind, and either to consume it himself, or transport it to places
where he may find a market. In those countries, the prince can levy
few or no taxes, but in the same manner: And as he will receive small
benefit from impositions so paid, it is evident that such a kingdom
has little force even at home; and cannot maintain fleets and armies
to the same extent, as if every part of it abounded in gold and
silver."

Hume's own proposed monetary policy:

"From the whole of this reasoning we may conclude, that it is of no
manner of consequence, with regard to the domestic happiness of a
state, whether money be in a greater or less quantity. The good policy
of the magistrate consists only in keeping it, if possible, still
encreasing; because, by that means, he keeps alive a spirit of
industry in the nation, and encreases the stock of labour, in which
consists all real power and riches. A nation, whose money decreases,
is actually, at that time, weaker and more miserable than another
nation, which possesses no more money, but is on the encreasing hand."

And here's Hume talking about the effects of people hoarding money being equivalent to a reduction in the total supply of money:

"It is also evident, that the prices do not so much depend on the
absolute quantity of commodities and that of money, which are in a
nation, as on that of the commodities, which come or may come to
market, and of the money which circulates. If the coin be locked up in
chests, it is the same thing with regard to prices, as if it were
annihilated; if the commodities be hoarded in magazines and granaries,
a like effect follows."

Hume sounds a lot closer to Scott Sumner than to MMT.

Ralph: "Quite right: I suspect there is more cliché here than empirical evidence."

Think about asset prices. A freehold house costs more than a 99-year lease, which costs more than a 1 year lease. The only difference is different expectations about the value of the right to live in that house 2 years from now and 100 years from now. That is empirical evidence that expectations matter.

Most people change their car's oil, because they expect that if they don't the car will stop working sooner.

I can imagine a world in which expectations of the future didn't matter. There would be zero saving and investment in that world.

@W Peden

"But I thought that the money was provided as needed?" At the asking price to those with good credit. Who said it was free? The point is it isn't rationed, and deposits don't come first. Even the broadest of broad money isn't free.

"If you mean anyone can get a line of credit, then no. If you mean anyone can create a deposit, then no."

I'm afraid I was using money in a different sense. When you talk about banks creating money, your talking about deposits by implication in a fractional reserve system that works like the US one (not all do).

When I say anyone can create money, I mean anyone can create a medium of exchange, store of value and unit of account. If he can persuade others to use it, it's money. If it's convertible to dollars and has a useful ambit, then it's useful money. There's lots of it out there, created by different people/organizations, usually for use within a community and because it avoids onerous regulations - gambling, taxes, banking, need to control the community money supply and prevent inflation...

So I can deposit a deposit indirectly by converting currency, But I can't create one by this means in the currency of the deposit. This has, of course no effect on the money supplies in either currency.

There's a ton of it, once you start looking.

What if expectations are based on "Future demand"? and NOT inflation?

If my business forecast show that I am operating at 70 percent of capacity and demand is flat, I am NOT going to expand no matter what the interest rates. Unless some one pays me to expand or BigG buys a lot of product, the risk for Return on Investment will be too high. What many seem to not understand is that Return on Investment (and associated risk) is a function of DEMAND. When demand tanks, as it has in this depression, Risk SKYROCKETS. Money is an asset. Capacity is an asset. Excess capacity can have NEGATIVE return on investment. Money at Zero percent real interest is better to hold than Excess capacity at negative return.

What needs to change is not the inflation expectations, but the Demand expectations. The idea that we will have inflation when labor is in over supply and most products are in over supply is laughable. This is why it is so hard for monetary policy to raise expectations without help on the demand side from fiscal policy. Fiscal policy must increase the demand for labor or the demand for goods and services for monetary attempts to increase inflation expectations to be halfway credible.

-jonny bakho

" A freehold house costs more than a 99-year lease, which costs more than a 1 year lease. The only difference is different expectations about the value of the right to live in that house 2 years from now and 100 years from now. That is empirical evidence that expectations matter.

Expectations matter but the NPV of a house 99 years from now is effectively 0. You have additional rights with a freehold, a different tax status and the freehold is better collateral. That's enough for a price difference.

What's the difference in value between a 99 year lease and a 199 year lease? Not much, I'd think.

Peter N,

"At the asking price to those with good credit. Who said it was free? The point is it isn't rationed, and deposits don't come first. Even the broadest of broad money isn't free."

If money is anything other than free, then there can be more or less of it than needed. Compare this to, say, Nicholas Kaldor's model of endogenous money where money is always in equilibrium as it adjusts automatically to the terms of trade.

"I'm afraid I was using money in a different sense. When you talk about banks creating money, your talking about deposits by implication in a fractional reserve system that works like the US one (not all do)."

Sure...

"When I say anyone can create money, I mean anyone can create a medium of exchange, store of value and unit of account. If he can persuade others to use it, it's money."

So it's not quite the case that "anyone can create money", but rather anyone of who can persuade others to use something as money can create money. Anyway, we're getting a bit pedantic and esoteric here.

The money that is an asset to one person, is a liability on a bank's balance sheet somewhere. (Think about finding a purse with a gold coin and a French franc note in it.). So recessions could be an unwillingness to hold the liability, rather than an excess demand for the asset.

"Money is an asset. It's also a very long-lived asset (unless inflation is high)."

This confuses me. Would you say that an overnight loan is a very long lived asset? Well, that's what "money" (e.g. bank account) is, right?

W Penden,

We can retire the debt with a Trillion Dollar Coin, or a series of Coinz. We talk about this over at monetary realism.

I agree with Dan K. Instead of giving some mental telepathy to get spending going by increasing lending, why not just give actual poor people money? There is no expectation of future good times necessary to get more spending. For people in the lower 40% of the income distribution, just giving them money would be enough to induce spending.

@Determinant:
Hume was wrong. A banker, or any other business person, can shift from "profit-maximization" mode, where increased profit equals increased risk, to "balance-sheet preservation" mode where additional risk is unwelcome as it would injure the balance sheet and imperil the firm.

In the first case the income statement is more important than the balance sheet, in the second the balance sheet trumps the income statement.

You can't talk to a banker about risk who can't look past his balance sheet, he's not crazy, just on a different page. His needs and your needs no longer coincide and it has nothing to do with you.


well, lets talk to a banker familiar with credit models: a banker these days will say that preservation of the balance sheet and profit maximization are the same thing. preservation of the balance sheet (capital) means minimizing losses, generally because unemployment is high and delinquencies are large. minimizing losses is the same as maximizing profit.

The only "switching" going on is from recession to growth.

Lowering unemployment has the dual effect of reducing delinquencies/defaults and presenting additional loan growth opportunities.


http://research.stlouisfed.org/fred2/graph/?g=71h

same data on a scatter plot (unfortunately FRED does not let me condition on negative home prices and use the quarterly series, but this illustrates the point):

http://research.stlouisfed.org/fred2/graph/?g=71i

Mike S,

Absolutely: in a liquidity trap, it's a scandal that we haven't totally monetised the debt (although this wouldn't have any effect whatsoever on aggregate demand, because it would just be an asset swap). We can conclude that the Obama administration and the UK Labour/Coalition governments are the most fiscally incompetant governments in all of history for ignoring this costless way of retiring all the national debt forever.

(It's rather fun to drive this liquidity trap malarky to absurdity.)

As for giving money to the "poor": what do you do when you want to cool down the economy? Take that money from the bottom 40%? And what do you buy from them?

Max: ""Money is an asset. It's also a very long-lived asset (unless inflation is high)."

This confuses me. Would you say that an overnight loan is a very long lived asset? Well, that's what "money" (e.g. bank account) is, right?"

A lovely question. I like that one. It made me think. (I am not being sarcastic, just in case it sounds like it.)

A house is a long-lived asset. What about an IOU for delivery of one house one day from now? Would we call that IOU a long-lived asset? Well, the value of that IOU will depend on the value of the house many years from now. If you learned the house had untreatable woodworm, and would fall down 50 years from now, that would reduce the value of the overnight IOU. Now imagine a second IOU that promised to pay the first IOU tomorrow. Same thing. Now imagine a sequence of such IOUs, stretching off into the distant future. The value of the current IOU depends on the second, which depends on the third, etc.

Gotta go. Back later.

@jonny bakho

I agree with a lot of what you are saying but disagree with the conclusion. Let me offer the observation:

The CFO of your company gets the new quarterly economic presentation from Goldman Sachs (who helps them place the bonds to buy the factory). It says:


The Fed has announced a new ngdp target. The Fed aims to close the output gap more quickly than the current forecast, over a 1-2 year horizon, thereafter they will target a 4% ngdp growth path. It is studying the costs and benefits asset purchases and other operations to further this goal, likely to be undertaken within sevveral months.

Now, you are in a competitive industry and dont want to lose market share. You place a 30% probability that this will work. However, the stock and bond market took off, so certainly other people feel this will work. Since you dont want to lose market share you update your business plan given your 30% probability weighted forecast and ramp production somewhat to build some inventory, using overtime. So does your competitor.

The overtime wages paid flow back into the economy (and your workers feel more confident so they spend more), some of which ends up as higher demand for your product confirming some of your forecast. By the way, not all sectors of the economy are at 70% capacity, some are growing (like health care, just slower than trend) and some growing rapidly (ipads).

As the multiplier effect kicks in, your probability weighting that this will work goes up and you actually hire some people.

The Fed may or may not have to buy assets to prove its committment (probably).

Nevertheless, in the US here we have circa 4.5% growth right now with a fiscal contraction. So certianly 5 or 6% is feasible with more Fed stimulus.

Yes, Nick, and Hume also imagined helicopeter drops, at least as thought experiments. Now in our time what do you think Hume would have proposed as a method for the "magistrate" to keep the supply of money "ever increasing"? That sounds like government spending to me. Why doesn't Scott Sumner go ahead and propose some of it?

Do you think Hume - who disliked banks altogether - would have been impressed with a policy of increasing bank reserves in a credit monetary system where those reserves consist only in easily manufactured electronic balances that are accommodatingly supplied by the government at almost zero cost whenever a banker extends credit?

Or I wonder if Hume has any passage in which he said, "The wise policy of the magistrate consists in keeping spending ever increasing by announcing to the subjects his conviction that spending shall ever increase." I can't think of one. That sounds more to me like one of the things he would have classified as "superstition" - in this case the popular attribution of occult powers to authority figures.

By the way, Hume never proposed anything like a hot potato effect. He argued that local increases in the supply of money caused more spending because until the money was spent out into the economy and prices had risen as a result, the new money had just as much purchasing power as an equal quantity of the existing money. So the people who receive the new money are thereby proportionally and temporarily richer, and richer people spend more than poorer people. His account was also based on the idea that labor doesn't know what is going on, and so doesn't demand higher wages.

What he rejected was the notion that there could be a shortage of money, since he thought that whatever quantity of money was in existence would "find its level" in the markets in which monetary commerce was already taking place. I don't believe he ever argued that economic downturns were caused by anything that could be called a monetary disequilibrium, although he understood very well that they could be caused by the over-extension of credit and speculative bubbles.

johnny bakho: "What needs to change is not the inflation expectations, but the Demand expectations."

You can interpret NGDP targeters as saying exactly the same thing. NGDP, by definition, =PtimesY Think of a particular value of P.Y as a rectangular hyperbola Aggregate Demand curve, with Y on the horizontal axis and P in the vertical axis. What we want to do is shift that expected future AD curve to the right, so that people will expect some mixture of higher future P and higher future Y. We don't know what that mixture will be, because that depends on the slope of the Short Run Aggregate Supply curve, though we hope it's mostly higher future Y. (If the SRAS curve is vertical, so that only P increases, then we are wrong, the Real Business Cycle economists are right, and increasing Aggregate Demand won't do any good anyway.)

Plus, what dwb said. Keep rolling dwb!

W Peden: "As for giving money to the "poor": what do you do when you want to cool down the economy? Take that money from the bottom 40%?"

Exactly. It is very easy to advocate a fiscal policy that increases AD. But unless someone who argues for a particular fiscal policy is willing to argue for the exact same policy in reverse when we need to reduce AD, you know they are just "One-way Keynesians", and using AD arguments insincerely to hide some other agenda.

Similarly, some people argue we should halve debts to increase AD. I haven't heard any of them say we should double debts when we want to reduce AD.

Well MMTers quite explicitly make clear that taxes should be used to regulate AD. And you frame the question in a loaded manner. The point is that you wouldn't want to tax so aggressively that you send the economy back into a recession or depression. The goal would still be full employment.

wh10,

As Nick Rowe says, notice the implicit agenda here: raise public spending to increase AD; raise taxes to reduce AD. Such a programme is inevitably more political than a monetary stimulus, where you raise and reduce AD symmetrically and the incidence falls on the same group of people.

If you want to argue the case for bigger government and higher taxation, then a non-cyclical case has to be made. If I was cynical, I would say that the lasting popularity of the liquidity trap (in all its myriad forms) is it allows the case for "tax and spend" to be put in terms of unemployment vs. employment, which is a much more powerful argument than standard egalitarian rhetoric. However, I think that this is a case where correlation doesn't equal causation: there is a common factor behind the fact that those sceptical of marketry and devoted to the idea of the power of fiscal policy are also usually very credulous of the ability of government spending to solve all sorts of other problems; and vice versa in the case of supporters of monetary policy.

Which is why I'm dubious of the use of terms like "idealogue" and "dogmatist" in monetary policy vs. fiscal policy debates: BOTH sides have prior moral and epistemological committments. Economics is useful because, while we're all entitled to our opinions, we're not entitled to our own facts and reality is a constraint on both sides, so we need to find out how economies work.

Nick Rowe,

When you agree with me, you agree with yourself: I learned that point from you, on this blog. Frankly, I like the idea of just sending round cheques to every adult- a negative poll tax, if you will. However, I don't like the idea of a positive poll tax or asymmetric AD policy.

That said, if there was some special reason why OMOs and monetary policy generally was unavailable/impossible, then there could still be symmetrical fiscal policy via funding policy changes: either underfund public sector borrowing or switch borrowing from the non-bank sector to the banking sector. Both will increase the quantity of broad money.

The SRAS is positively sloped when businesses react to rising prices by hiring an additional unit of labor. They do so, in turn, when they feel that additional unit will be profitable.

How does the above fit with recent experience? We have the highest (at peak, actually) NIPA profits to GDP we've ever experienced in a recovery, yet employment growth is lackluster. Is the marginal profit from an additional labor hire dramatically lower than the average? Unlikely. Perhaps the cost of capital for the investment needed to produce that new hire is prohibitive? No, the real corporate WACC is quite normal right now and corporate bond issuance has been booming. Yes, small businesses are another matter entirely, which implies NIPA (domestic) profits are unevenly distributed like never before. Is this uneven profits distribution an AD issue or a structural one?

Given this large firm dominance, is there perhaps a higher degree of oligopolistic competition than in previous recoveries? There are signs that new-firm entry is constrained by the reduced intensity of financial intermediation. Arguably this is a supply-side problem. For instance, the "failed technology" of home equity withdrawal has removed a key source of start-up capital.

Maybe businesses in aggregate are profitable but don't think they will find a buyer for that marginal unit of production? Except we have expected RGDP growth of around 2%-2.5%. NGDP growth expectations are about 4-4.5%. This is not an indication of abnormal demand uncertainty on the part of businesses.

In short, businesses expect growth, margins are at peak, and the WACC is normal. Why haven't we seen less slope to the SRAS curve?

I don't really understand why a recession is described as due to "en excess demand for money". It seems rather the case that when the demand for money increases then unless suppliers lower their prices the number of transactions (and hence the level of economic activity) will diminish.

I'm also unclear why expectations matter so much. If the CB commits to stabilizing the price of money by adjusting the supply to match changes in demand then recessions should be avoided. It may perhaps be the case that this commitment will itself stabilize the demand for money but this seems more like an interesting side-observation rather than in any way key to the way that monetary policy should work.

Well, I didn't feel like I needed to trot out and explain the darn TC rule again. It's not like people here don't know me, or are unfamiliar with my proposed fiscal spending rule.

The TC rule is a fiscal policy rule which gives a suggested level of deficit spending (manifested through payroll taxes) for levels of unemployment, inflation, and population growth. The population growth is to account for per captia growth, which just gets swept away by most people.

But my particular rule isn't really the point here - it's the fact fiscal rules exist and have been proposed by far more prominent people than me. And at this point, to remain a credible person, one needs to recognize monetary policy has huge problems. So does fiscal. Get over it.

I'd point out beowulf also has a good fiscal spending rule, and Peter Orszag has a nice rule. I'm sure many people could come up with fiscal rules. By aiming them at payroll taxes, it's only 7% of someones paycheck. Heck, you could even mandate employeers show the payroll number to people every week so they aren't shocked at a lower paycheck when good times come around again.

And frankly my rule doesn't address the non-democratic Central Banks deciding it doesn't like growth and contracting credit when circumstances allow them to have some impact on credit creation, or having them ignore the law about employment and inflation. The target unemployment rate is 4% by law. Unemployment trumps inflation concerns, again by law.

http://monetaryrealism.com/mike-talks-romney-listens/#comment-6429

Then in terms of "debt", there I don't think people who want to reduce the overall level of indebtedness believe somehow this always and everywhere translates into a 1:1 correspondence with AD. Steve Waldman thinks we probably have too much debt, and reducing the level of private debt would be a "good thing." In todays particular situation, the level of indebtedness constipates monetary policy.

W Peden: Yep, if for some weird reason it were simply impossible for the central bank to buy and sell assets, then using helicopter money to increase AD and vacuum cleaner money to reduce AD would be the next best policy. Nasty when you need to go into reverse and use the vacuum cleaner, is the only problem. Or, as an intermediate case, if the only assets were physical assets like bridges, then have the central bank buy and sell bridges. If people want to say that's fiscal policy, then go ahead (where is the exact dividing line anyway, if say, it buys and sells shares in bridges, or bonds issued by bridge-owners). But recognise that the stock of money stays higher even after the central bank stops buying bridges.

Exactly. It is very easy to advocate a fiscal policy that increases AD. But unless someone who argues for a particular fiscal policy is willing to argue for the exact same policy in reverse when we need to reduce AD, you know they are just "One-way Keynesians", and using AD arguments insincerely to hide some other agenda.

I think this is a strange outlook Nick. Why in the world would someone want to advocate the exact same policy in reverse? If a field doesn't have enough crops growing, you sow some seeds and water the field. If the plants then start growing riotously and are chocking each other off, you don't go around removing seeds and water from the ground. Instead you mow, uproot or burn some of the excess growth.

From fact that the best way to develop and grow an economy might be to spend money among some population X doesn't mean that that the best way to tamp down the economy if it is growing too fast is to extract money from the very same population.

I'm still thinking about Max's good question.

Suppose there were a bit of paper, which gave the owner:
1. The (exclusive) right to live in a particular house for one day,
2. The right to sell that bit of paper to whomever,
3. The right to exchange that bit of paper for a second bit of paper dated the next day.

ownership of that bit of paper constitutes ownership of that particular house. The bit of paper looks like a one-day asset, but given 3 it lasts as long as the house.

On using fiscal policy to stabilize AD.

Why not just have a tax/subsidy on all final sales. Its a subsidy when AD is below target and a tax when its above. The further away from target the bigger the % of the tax/subsidy.

If expectations are really key then the tax/subsidy would always be neutral anyway.

Totally lost you as usual Peden, and as usual, you twist and read my words with inaccurate, loaded assumptions.

Nick said:

"But unless someone who argues for a particular fiscal policy is willing to argue for the exact same policy in reverse when we need to reduce AD, you know they are just "One-way Keynesians", and using AD arguments insincerely to hide some other agenda."

I arrived and said I will argue for the same policy in reverse - for the exact purposes of trying to prove I am not insincerely trying to hide some other agenda.

And I never argued for big govt and high taxes, so I am not sure where you got that. AD could be spurred with low taxes, too, and AD could be reduced through smaller govt too. The general goals I have in mind are full employment and price stability.

Dan: assume that total amount of water on your crops at time t is M(t)+V(t), where V is from rainfall and M is from irrigation. Let the optimum amount of water be A. Then optimum irrigation is given by M(t)=A-V(t). You need a countercyclical irrigation policy, in which irrigation is higher than normal when rainfall is lower than normal, and lower than normal when rainfall is higher than normal.

On Max's question,

An overnight loan doesn't mean that what is loaned has a value that lasts only overnight. Suppose A gives B a $50 bill on the condition that tomorrow B must give A a $50 bill plus a 1$ bill. As a result of earlier agreements and obligations, B then gives that $50 bill to C, and also receives from D another $50 bill plus two $1 bills. B then gives A the promised $50 bill and $1 bill. After our transaction is completed, the $50 bill in the hands of C, the $50 bill in the hands of A, the $1 bill in the hands of B and the $1 bill in the hands of A, still have the value they had before.

For a brief time, A also possessed a different asset, and B also possessed a different liability - the promissory note from B. When B then gives A the $51 dollars, that credit asset/liability is extinguished. B loses the credit liability, but in exchange loses the $51 cash asset; A loses the credit asset, but in exchange gains the $51 dollar cash asset. The IOU only had an overnight life; but the assets that the IOU was an IOU for have a much longer life.

Ron: that would work (if it's money-financed), except: a VAT also has microeconomic consequences. It causes a deadweight loss (roughly) proportional to the square of the tax rate, so that having a varying tax rate causes higher average deadweight costs than having a constant tax rate that collects the same average revenue. Also, it has distributional consequences too, that may or may not be desired.

This is part of a general rule: fiscal policy has lots of microeconomic objectives too. If fiscal policy is doing those micro jobs well, it can't also do the macro jobs well. Fiscal policy levers can't be in two different places at the same time.

wh10: "I arrived and said I will argue for the same policy in reverse - for the exact purposes of trying to prove I am not insincerely trying to hide some other agenda."

OK. I believe you.

In which case you have a genuine belief in a truly countercyclical fiscal policy. But now see my reply above to Ron Ronson.

Nick,

yes I would see the tax/subsidy as being being used purely to adjust the money supply. The subsidy would be funded by newly created money and the tax would lead to money being destroyed.

I need to research a bit to understand the "dead-weight loss" issue - but if the policy was applied to all final transactions (including perhaps transactions involving labor purchases) its not obvious what distortions this would cause.

I like this approach better than increasing the money supply via asset purchases or interest rate policy because it neither distorts asset prices nor leads to an increase in bank lending - both of which appear to carry some risk.

There are pros and cons to monetary policy as well.

Look, it sounds like our macroeconomic goals are similar, broadly speaking (economy near full capacity and price stability). And there is a lot of similarity between your comment that there is an excess demand for financial assets and the way post-keynesians say it. The big disagreement is how do we get there, and many of the post-keynesians don't really buy the monetary policy solution. But I am all for trying it and being proved wrong.

OK, Nick, you can stick with a denial of the second law of thermodynamics if you want. But decelerating some large process in a complex dynamical system is not the same thing as decelerating the causal factor that originally accelerated it.

I see nothing wrong with being a "one-way" Keynesian, since dynamic processes have a preferred time direction and a preferred spatio-temporal direction of causal propagation.

If the Kingdom of Horsemen is impoverished, and the husbandmen who breed and raise the horses that supply the cavalier armies are do not have enough feed to breed and raise horses, then you address the problem by getting them more feed. If you overshoot and there are now wild horses stampeding the fields and rogue horsemen pillaging the peasant, you don't address the problem by taxing feed from the husbandmen. You have to round up the extra horses and the pillagers, while adjusting the rate of horse breeding to get it just right. Stimulating the economy at the ground level of consumers and small business may lead eventually to a growth of prosperity that develops into a flow of wealth toward the top of the economy, a glut of luxury goods and speculative lending and bubbles among those with a lot of surplus capital. At that point, to slow things down, you have to go after the surplus, not the ground level.

This idea that the economy has some sort of karmic balance that must be preserved, and that Keynesian demand stimulus in one time has to be balanced off by an opposite demand de-stimulus at a later time, and that every deficit now must be matched with a surplus later, is encountered in a lot of the things Krugman says - and it drives me crazy.

Re "This is part of a general rule: fiscal policy has lots of microeconomic objectives too. If fiscal policy is doing those micro jobs well, it can't also do the macro jobs well."

Why not ? If you use tax/subsidies to optimize AD there is nothing to stop you using other fiscal policies to accomplish other objectives. You could for example have a sales subsidy of 3% to increase NGDP, while at the same time taxing and spending in other ways for other things with no obvious conflict, unless I have missed something.

Of course if merely stating that you will use fiscal policy to stabilize AD is sufficient to prevent it being needed then other fiscal policy can continue unaffected.

Ron: this Wikipedia page is an OK start, though it's not ideal. The area of the welfare loss triangle increases with the square of the tax rate, so ideally you want to have that tax rate constant over time.

Any fiscal policy will have the same issues. The optimal setting from the microeconomic perspective won't be the same as what's optimal from the macroeconomic perspective, and it can't be in two places at once. Lump sum taxes would seem to be an exception, since they don't cause deadweight cost triangles, but they have their own distributional consequences.

wh10 @01.50pm. Agreed. And in practice, in the Canadian context, I supported the use of fiscal alongside monetary, provided we tightened fiscal policy up again as soon as we were able (which seems to be happening). Because, even though I think that monetary policy, done properly, can do the job alone, I didn't want to take the risk: that it would be done properly; that I might be wrong. Belt and braces; give the bear both barrels at once; choose your metaphor. I would be less sanguine about fiscal policy in the US, given the politics and the higher Federal debt/GDP ratio and prior deficit. Canada had a surplus going into the recession, so taxes would need to be cut and/or spending raised at some future point in any case.

"Expectations matter a lot for the demand for long-lived assets, and hence for the price of long-lived assets."

You mean, more so for things like houses, factories, cars as compared with paper plates, plastic spoons, frozen foods, children's clothes, etc?

In other words, expectations matter more DEPENDING ON THE LENGTH OF THE STRUCTURE OF PRODUCTION INVOLVED.

Wonder it that might have anything to do with the cycle of boom and busts and all that goes with it.

Hmmmm.

Ya think?

Nick,

Thanks for the wikipedia reference - I did learn from it but I still don't really see how it applies here.

the article provides an example "If the price of a glass of beer is $3.00 and the price of a glass of wine is $3.00, a consumer might prefer to drink beer. If the government decides to levy a beer tax of $3.00 per glass, the consumer might prefer to drink wine. The excess burden of taxation is the loss of utility to the consumer for drinking wine instead of beer, since everything else remains unchanged." But if the tax was applied equally to beer and wine then where is the loss of utility ?

I can see that if we were in equilibrium (relative prices including the price of money correctly aligned to reflect underlying preferences) then even a general sales tax/subsidy would distort and move the economy away from equilibrium. However if the demand for money has increased but supplier are unable to quickly reduce prices to reflect this then an increase in the money supply would be beneficial. I believe a sales subsidy would be the less distorting than any other means to achieve this increase because it would very directly get "marginal buyers" back into the market and lead to new equilibrium that would be very similar to what would have been achieved had prices been able to fall immediately following the change in the demand for money.

Greg: Thank God! Someone who doesn't need to be convinced that expectations might matter, and have this explained to him!

Ron: Yep, if truly all final goods were taxed at the same rate, this wouldn't be a problem. But we don't tax: leisure; the joys of a pleasant job; home production; etc. And then there's tax evasion.

A subsidy is exactly the same as a negative tax. It has a welfare-loss triangle just like the tax triangle, only on the other side of the supply and demand curves.

"But we don't tax: leisure; the joys of a pleasant job; home production; etc. And then there's tax evasion."

Good point - there would indeed be some market distortions but would they not be less than those from monetary policy that would either(if the policy is carried out via lowering interest rates) increase banks lending and cause the kind of problems the Austrians and post-Keynsians are always highlighting, or (if the policy is carried out via asset purchases) cause asset-price inflation , and changes to the structure of demand to reflect the preferences of those whose assets were bought ?

Ron: suppose i were in charge of monetary policy and you were in charge of fiscal. I would be keeping NGDP on track regardless of what you did. If at some point you said "Hmmm, I think interest rates are too low and I want to loosen fiscal policy to increase interest rates" I would shrug my shoulders and say "Do whatever you want to do, for whatever reasons you want, but just don't think you will shift the AD curve by doing that, because I will make sure it doesn't shift".

Yes, at this point, you might say the argument is becoming semantic. Are monetary and fiscal policy doing different jobs, or are they sharing the same job? Depends how you define "monetary policy". Does it mean setting NGDP, or does it mean setting a rate of interest?

wh10,

"Totally lost you as usual Peden, and as usual, you twist and read my words with inaccurate, loaded assumptions."

You say that taxes should be used to regulate AD. The original context was talking about state handouts to boost AD, that is Mike S's comment "Instead of giving some mental telepathy to get spending going by increasing lending, why not just give actual poor people money?"

Now, if you disagreed with what Mike S posted and if you want to do it entirely through tax cuts/rises, why didn't you say so?

Nick Rowe,

I was actually thinking of something even more mindlessly automatic: the government spends as before, but funds its expenditure differently.

Of course, in practice that's quite unrealistic: governments facing recessions have tremendous pressure to win popularity, and a very interventionist fiscal policy is a way to do it. Hence things like "cash for clunkers", Green Jobs and loan guarantees for small businesses. Whatever the fiscal multiplier of such spending, it has a vastly higher political multiplier (the important multiplier for a democratic government) than simply switching from selling news bonds to getting loans from banks.

You'd obviously have to make sure that monetary policy and fiscal policy were aligned - as the govt ultimately controls both then in theory that should be achievable.

I'm assuming here that NGDP targeting is the desired goal and I'm arguing the view that fiscal policy (in this case defined as stabalizing NGDP via a variable tax or subsidy on all transactions) seems more direct and less distortionary than monetary policy (defined as attempts to stabilize NGDP by either setting interest rates or "quantitative easing"-type asset purchases).

In my model there would in fact be no monetary policy as fiscal policy would do all the work, and fiscal policy would consist of just calculating the level of tax/subsidy needed to achieve an optimum NGDP target. Any other fiscal policy the govt chose to implement would be to achieve non-economic social and/or political goals and be outside the scope of the GDP-stabilizing policy envisaged here. These additional polices would ideally have to operate on a "balanced budget" basis.

Ron: "In my model there would in fact be no monetary policy as fiscal policy would do all the work,..."

What does "no monetary policy" mean? What does "doing nothing" mean?

This is getting a bit zen.

I defined monetary policy as 'attempts to stabilize NGDP by either setting interest rates or "quantitative easing"-type asset purchases'. I can see you could just as easily define it more broadly as 'polices that alter the money supply and therefore affect NGDP".

However that seems irrelevant. I'm really just trying to compare different techniques for stabilizing NGDP in terms of effectiveness and non-distortionary effects.

If expectation are the key to stabilizing he demand for money then what matters is not if a policy will actually work if tested but whether it will be perceived by the public as going to work. If the public believes it will work then it will never actually need to be tested.

Perhaps then economists, rather than debating which policies are optimal, should actually be conducting market-research on which policies the public would most likely believe in ?

OK. You are the government. You control lots of different fiscal levers, which affect lots of different things in lots of different ways. You care about: NGDP; and a lot of other things as well.

I am your humble servant monetary policy. I only control one lever (ultimately, the size of my balance sheet). So I can only target one thing. One restriction is that the thing I am targeting must have $ in the units. I note that NGDP has $ in the units. What would you like me to target? Would you like me to target NGDP, so you can delegate that responsibility to me, freeing you up to move your levers to try to attain as many of your other objectives as possible? You will never have as many levers as you want to have, so it would be unwise for you not to delegate one of your objectives to me, or tell me to "do nothing".

Would it be possible for a central bank not to target some macroeconomic quantity, but simply set a ceiling of some kind and otherwise get out of the way of the rest of the government? Couldn't they just say: "We're going to stay out of the way of the politicians, unless inflation appears poised to exceeds 5% (e.g.), in which case we will then raise interest rates."

For example, if the fire department says "No more than 362 people in this club at any time" we wouldn't say that the fire department was "targeting" an attendance of 362 people for the club's nightly attendance. My beef is with the idea that the central bank can actually deliver the kinds of economic performance we need.

Peden, I meant some combination of fiscal policy more generally, but I was responding to your comment that one day you might have to take "money back." That sounded like you were referring to taxing. Of course, you could alternatively withdraw govt spending.

wh10,

I see. In practice, of course, I expect it to generally be easier to raise taxes that cut spending, although in some political situations (like the US recently) it seems that cutting taxes can become just as difficult as cutting spending.

Dan: so you are saying I can do whatever I feel like, as long as inflation is less than 5%? "Cool!" replies the crazed deflationista, "I think I will tighten monetary policy and aim for a repeat of the Great Depression!"

Nick, I think this is the best example of the power of expectations: [link embedded here NR]

A clear target and a credible commitment, and the exchange rate immediately changed to reflect it. I don’t think there’s any other way to interpret this than as an expectation driven event.

Dan: so you are saying I can do whatever I feel like, as long as inflation is less than 5%? "Cool!" replies the crazed deflationista, "I think I will tighten monetary policy and aim for a repeat of the Great Depression!"

How did you get that? I suggested that the CB's policy should stay out of things unless inflation gets too high. Not that it should do whatever it likes. Saying that it will accept whatever inflation rate happens to occur as long as it is not above certain number is not the same thing as targeting a specific rate of inflation or spending. And it is certainly not the same thing as interfering to cause deflation.

I thought you guys had this new argument to the effect that fiscal policy wouldn't work because people would fear that the Fed would step in and counteract the effects of fiscal policy. So their policy should just be not to do that, unless inflation gets really out of control.

What I want is for people to get out of the mindset of thinking that the central bank can make lots of good things happen. They can't. The bank can instead just determine stay out of the way as the folks with the real ability to make things happen get to work.

"You control lots of different fiscal levers, which affect lots of different things in lots of different ways. You care about: NGDP; and a lot of other things as well."

What if you think that if you have stable NGDP then the market can sort out everything else for itself - you wouldn't have any other policy objectives and then you could choose the best policy to achieve that one goal.

A clear target and a credible commitment, and the exchange rate immediately changed to reflect it. I don’t think there’s any other way to interpret this than as an expectation driven event.

That's like the Fed Funds rate curiouseconomist. If the Fed makes a commitment to control a rate in a market whose rates they actually do control, then people in that market will jump to that rate right away. Same with foreign exchange. With a rate like the total volume of nominal spending in the entire economy, not so much. It's like expecting them to control the tides.

curiouseconomist: I think that's a good example. But I was just literally 5 minutes ago reading your excellent long comment on Chris Dillow's blog. And I think the evidence you marshal there is more important. And I was wondering who you were, and then returned here to find your comment!

And I was just wondering whether it would be possible to repeat what you did there, only using NGDP forecasts instead of RGDP forecasts, and comparing countries? If there are RGDP forecasts and inflation forecasts, it should be possible to construct NGDP forecasts. Then repeat what you did in your comment, to argue it should have been quite possible for central banks to have loosened monetary policy to prevent forecasted NGDP falling like that?

Dan: "How did you get that? I suggested that the CB's policy should stay out of things unless inflation gets too high. Not that it should do whatever it likes."

OK. I knew (of course) that you thought it's not OK for the central bank to do whatever it likes, as long as inflation is less than 5%. But what does "staying out of things" (or "stay out of the way") mean? Since you are not indifferent among all the things the central bank might conceivably do, is there one out of that large set of things you would most prefer it to do?

"If the Fed makes a commitment to control a rate in a market whose rates they actually do control, then people in that market will jump to that rate right away. Same with foreign exchange. With a rate like the total volume of nominal spending in the entire economy, not so much. It's like expecting them to control the tides."

If Chuck Norris works for the overnight rate, and the exchange rate, and if nominal spending depends on interest rates and exchange rates, and on expected future nominal spending, which in turn depends on expected future interest rates and expected future exchange rates, then why can't Chuck Norris work for NGDP too?

Ron: "What if you think that if you have stable NGDP then the market can sort out everything else for itself - you wouldn't have any other policy objectives and then you could choose the best policy to achieve that one goal."

If I really didn't care about taxes and government spending, except insofar as they influenced NGDP, then you would be right. I would have 3 policy levers (G,T, and M) and only one target (NGDP) so I could ignore any 2 of those 3 levers. But I do care about G and T, quite apart from their effects on NGDP.

@Nick

If Chuck Norris works for the overnight rate, and the exchange rate, and if nominal spending depends on interest rates and exchange rates, and on expected future nominal spending, which in turn depends on expected future interest rates and expected future exchange rates, then why can't Chuck Norris work for NGDP too?

I think because nominal spending depends on a lot more than just interest rates and exchange rates. If Chuck Norris says "I intend now to use my patented spin kick maneuver to break 15 bones in Dr. Chan's body. Take bets now on how many broken bones Dr. Chan will have when I'm done," then a lot of people will bet somewhere around 15. But Chuck Norris might say, "I expect 75,000 additional broken bones in America between now and the end of the month. Place your bets." I don't think this will have much impact. And you can count on one hand the people who will go out and buy broken bone insurance in response to Chuck's statements.

Now I admit it's a little iffier to try to predict the effect of a central banker's statements. Since fewer people have heard of Ben Bernanke than have heard of Chuck Norris, and since even experts seem to be in some doubt about what it is exactly Bernanke does, then it is harder to say what number of people would modify their behavior in response to some statement he made.

Dan: "I think because nominal spending depends on a lot more than just interest rates and exchange rates."

Agreed. Monetary policy will never be able to control actual NGDP precisely, because it depends on a lot of things. It's going to be a question of how precisely, and how quickly it can react to new information on those other things, and what information it has. Just like trying to keep the speed of a car constant when that speed depends on a lot of things, not just the gas pedal, especially if there's a lag in the speedometer.

But controlling expected future NGDP is going to be easier. That's because other people don't know what actual future NGDP will be either. And presumably the central bank knows all the information they know, and can make as good a guess as they can, and can guess what they can guess. Plus, it can even ask people what they expect future NGDP to be. Or watch a futures market to learn what people expect in real time (a la Scott Sumner).

It's the same as targeting inflation. Central banks can't do it exactly, but they can do it roughly. Targeting expected future NGDP should be easier.

@nick
"Suppose there were a bit of paper, which gave the owner:
1. The (exclusive) right to live in a particular house for one day,
2. The right to sell that bit of paper to whomever,
3. The right to exchange that bit of paper for a second bit of paper dated the next day.

ownership of that bit of paper constitutes ownership of that particular house. The bit of paper looks like a one-day asset, but given 3 it lasts as long as the house."

Congratulations. You just reinvented the repo, which you seem to think is money. I'll accept that.


Peter N: No, I think I just reinvented the title deed to a house! But I don't think it's money. Individual houses don't work very well as money. It costs so much to do the home inspection, pay the realtor's fees, the lawyer's fees, etc.

Individual houses don't work very well as money.

true, but mortgage backed securities might.

@Nick

"that would work (if it's money-financed), except: a VAT also has microeconomic consequences. It causes a deadweight loss (roughly) proportional to the square of the tax rate, so that having a varying tax rate causes higher average deadweight costs than having a constant tax rate that collects the same average revenue. Also, it has distributional consequences too, that may or may not be desired."

You have to be careful here. The micro level deadweight loss is embedded in an economy. Income tax in the US not only has the deadweight loss of a tax, but also has a whole set of extra losses that are systemic. It's the systemic losses you want to minimize, not the immediate losses from ideal collection.

Suppose at the micro level you include costs of collection for both supplier and customer. The actual tax loss at least generates revenue. If this loss is deadweight, the other losses are deader than dead. These deaderweight losses plague modern tax systems.

I suppose one may care about G and T because one wants to redistribute income or change the supply and demand curves of certain industries (for whatever reason).

You would do this via laws , taxes and subsidies.

The combined effect of these laws, taxes and subsidies would give you either a balanced budget, a deficit or a surplus. If it was a deficit you could fund this via either borrowing or printing money, if a surplus you could pay down govt debt or destroy money. Either option would have some effect on NGDP. If you were also targeting NGDP then you may also have to make further adjustments to achieve the target. One would then want to use the most efficient lever to achieve this.

One could define "fiscal policy" as those policies that aim for income redistribution or other kinds of market intervention and "monetary policy" as those policies that allow the NGDP target to be met. As long as the latter are neutral in respect to their effect on the former then one should just choose the most efficient lever. I have not seen any argument that dissuades me from my view that tax/subsidy (on all transactions) is more efficient than influencing the money supply via interest rates and/or asset purchases.

@Dan Kervick,
You wrote:
"I thought you guys had this new argument to the effect that fiscal policy wouldn't work because people would fear that the Fed would step in and counteract the effects of fiscal policy."

I've been staying out of this but that particular statement really irked me. There's nothing new about this at all. This is pretty old and very conventional macro. I think it's safe to say nearly every economist by graduate school has been exposed to a demonstration using the IS/LM model of the circumstances under which fiscal and monetary policy trade places in effectiveness (fixed versus flexible exchange rates).

Under a flexible exchange rate regime fiscal policy is generally considered impotent since it is subject to the reaction function of monetary policy. It's only the fact that some economists think we are now in a liquidity trap that fiscal policy may have traction, but that is of course subject to enourmous disagreement.

P.S. There are other channels for the monetary transmission mechanism than the interest rate and exchange rate. In particular, if I remember correctly Mishkin's intermediate textbook lists seven others: Tobin's q Theory Channel, Wealth Effect Channel, Bank Lending Channel, Balance Sheet Channel, Cash Flow Channel, Unanticipated Price Channel and Household Liquidity Effects Channel. This of course implies that monetary policy's ability to influence nominal spending has numerous pathways.

I simply don't see a mechanism for the Fed to induce wage inflation without help from fiscal policy, or at least for fiscal policy to stop pulling in the wrong direction. Monetary policy is important and works well for some situations. Monetary policy works well to balance economic growth when the economy is within an area close to full employment and close to the inflation target.

Monetary policy is not very good for addressing speculative bubbles. Regulatory is the best and most appropriate tool for bubbles.

Fiscal policy is the best mechanism to intervene during periods of slack demand and labor underutilization whether from structural or cyclical reasons.

All 3 policies work best when they are pulling in the same direction. Monetary policy, no matter how good, cannot compensate for truly awful regulatory or fiscal policy.

You're not really done with a definition of monetary policy until you say what the central bank can buy, how much of it and what you expect the effect to be.

This paper discusses channels, central banks and the business cycle. I thought it was pretty good. Much too good to try to summarize.

http://web.efzg.hr/dok/fin/mivanov/Ivanov-BESi-2009-Paper-proofread.pdf

Under a flexible exchange rate regime fiscal policy is generally considered impotent since it is subject to the reaction function of monetary policy. It's only the fact that some economists think we are now in a liquidity trap that fiscal policy may have traction, but that is of course subject to enourmous disagreement.

Mark, is there a model that explains how monetary policy is also impotent because fiscal authorities will always act to cancel out the effects of monetary policy, too?

The Fed is a creature of the US Congress, created by an act of Congress, which has all of its powers by virtue of a delegation of powers constitutionally assigned to congress. Congress can claw back as much of that power as it wants at any time. They could even move the central banking function to the Treasury - or to a committee in Congress itself. Short of that, if a fiscally energetic government of the future is concerned that the monetary authorities are preparing to act in a way which will neutralize the economic impact of their polices, they can write and pass a simple law: "Don't".

It seems strange to regard these highly contingent institutional and political arrangements, and the policy fancies of the neoliberal era, as though they are some kind of hard-wired economic laws.

@Dan Kervick

"Short of that, if a fiscally energetic government of the future is concerned that the monetary authorities are preparing to act in a way which will neutralize the economic impact of their polices, they can write and pass a simple law: "Don't"."

Congress has intervened in monetary policy before. They did it in the 1930s.

Right Peter N. So many of these economic models seem to set up the world as a very simplified game with a very limited number of permitted moves - which just happen to be the only moves the model-builders want us to consider.

@Dan Kervick,
This is less a political matter than an economic matter. You may not like the fact that the earth revolves around the sun, but there it is, and no matter how many acts of congress you pass nothing will change that fact.

That same model shows that monetary policy is ineffective and fiscal plicy is effective with a fixed exchange rate regime. But with the collapse of Bretton Woods in 1971 I think it may be too late to put that genie back in the bottle. (And, prior to the 1951 Accord, the Fed *was* largely subservient to the Treasury.)

P.S. I sometimes think that the main problem with Post Keynesians and MMTers is that they don't acknowledge the change in exchange rate regimes. Much of what they say might have been appropriate 40 or more years ago, but now it is largely irrelevant.

Mark, the central bank reaction function is derived from rules that are expressions of policy preferences. How can you regard these constructions as in any way to the revolution of the earth around the sun?

All you are telling me when you say that a central bank behaves in a way represented by a reaction function according to which it will offset fiscal expansion by raising interest rates is that central banks in the past have followed a Taylor rule or something like it. But aren't NGDP targeters among others explicitly proposing that the central bank not follow the customary rules? The reaction function isn't a law of nature - it is just a mathematized coding of recent standard operating procedure. If the procedure changes, then the mathematical models that presuppose it collapse.

On the issue of MMT and exchange rates, Warren Mosler's demand-side framework for full employment and price stability is built explicitly on a floating fx model:

http://www.epicoalition.org/docs/exchange_rate_policy_and_full_em.htm

Dan,
The link you provided points out some of the potential hazards of maintaining a fixed exchange rate in the post Bretton Woods environment (and a good argument can be made that thanks to the Triffen Dilemma that system was itself unsustainable). It also seems to suggest that fiscal stimulus is compatible with a floating exchange rate regime. But much of what it says in that regard is counterintuitive and contradicts simple conventional macroeconomic models.

Let me explain why in the context of the basic IS/LM model.

Let's assume we have flexible exchange rates, perfect capital mobility, and we attempt a fiscal stimulus. The increase in Government spending means there's an increase in total expenditures, therefore the IS curve shifts to the right and output and real interest rates increase. Because of the increased inerest rates there are capital inflows as foreign investors seek to purchase higher returning domestic assets. These investors are exchanging their currency for the more desirable domestic currency. This increased demand for the domstic currency causes the value of the domestic currency to rise on foreign exchange markets (i.e. it appreciates, e decreases). As e decreases, net exports decrease as domestic goods become relatively more expensive on international markets. As net exports decreases, total expenditures fall and the IS curve shifts to the left. The exchange rate will continue to appreciate, and the IS curve will continue to shift to the left until the capital inflow is halted (i.e., until the domestic interest rate equals the foreign interest rate). The new equilibrium is at the same level of output as the initial level.

The only alternative is for the money supply to be increased simultaneously in such a way that the exchange rate is maintained. And if you do that what was the point of doing the fiscal stimulus in the first place?

You're much better off using monetary policy to stabilize short run aggregate demand so that you can free up fiscal policy to be focused on long run aggregate supply issues.

Nick
"Exactly. It is very easy to advocate a fiscal policy that increases AD. But unless someone who argues for a particular fiscal policy is willing to argue for the exact same policy in reverse when we need to reduce AD, you know they are just "One-way Keynesians", and using AD arguments insincerely to hide some other agenda.

Similarly, some people argue we should halve debts to increase AD. I haven't heard any of them say we should double debts when we want to reduce AD."

These are both cheap shots. When you want to cool down the economy, there are fewer poor people to give money to. You don't have to increase debts, because higher interest rates do the same to effective demand for you. The liquidity trap, really is a special case.

"....there are fewer poor people to give money to"

Hence my point in another post about the possibility of having bigger automatic stabilisers.

Mark,
isn't your argument with capital inflows self contradictory. If capital inflows completely offset fiscal policy, and capitalists know that, then the capital inflows won't happen.

This sounds like a wonderful paradox - fiscal policy is ineffective, because it is effective.

But I think the key point is here:
"The only alternative is for the money supply to be increased simultaneously in such a way that the exchange rate is maintained. And if you do that what was the point of doing the fiscal stimulus in the first place? "


Because it is a DIRECTER way of doing what we actually want to do (give the unemployed jobs).

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