How can you get an economy INTO a liquidity trap?

We spend a lot of time thinking about how to get out of a liquidity trap. Maybe we can think more clearly about that question if we instead ask the exact opposite question.

But let's be a little more precise about our question:

How can you get an economy into a liquidity trap in such a way that someone else couldn't get it back out of that same liquidity trap just by reversing whatever it is you were doing? Because it's not really a trap if someone else can get the economy out of it.

I can get a car stuck. That's easy. Any fool can do that. But getting a car stuck so badly that another driver couldn't take over and reverse the car back out is a little bit harder. You have to do something that's irreversible to make it really stuck.

With cars, it's easy to think up lots of irreversibilities. Get it stuck going downhill (it's very hard to get permanently stuck going uphill, because you can nearly always just reverse back down again). Get it stuck resting on a tree stump with all four wheel spinning uselessly off the ground (happened to me once, where the Land Rover's 4WD was finally defeated).  And it's extremely easy to get a car permanently stuck if reverse gear doesn't work. What would be the economic equivalents of those sorts of irreversibilities that would make it possible to get an economy stuck and impossible for someone else to get it unstuck?

If monetary policy were loose enough, you would never get into a liquidity trap in the first place. The Zero Lower Bound on nominal interest rates won't be a constraint, for any conceivable shock, if you are targeting 100% inflation. Hitting the ZLB means you were running too tight a monetary policy, given the driving conditions, in the first place.

If one night I snuck in past security, locked the doors behind me, and took over the Bank of Canada, and if I were full of bad intent, I could very easily get the Canadian economy stuck at the ZLB. I would just tighten monetary policy, and announce loudly that I was tightening monetary policy, and force NGDP growth to be so negative that the equilibrium nominal interest rate would need to be negative. No problem.

But what happens when they finally break the locks, escort me out, and Steve Poloz and his old team take over again, and everybody sees that Steve is back in charge of monetary policy?

What could I possibly do, short of physically smashing the printing presses, that would prevent Steve from simply reversing what I had done? Where's the irreversibility?

The fact that I would have destroyed a lot of physical and human capital is a form of irreversibility. But it's not a form of irreversibility that would make it harder or impossible for Steve to get the economy out of the liquidity trap. If anything it would make it easier for Steve, because standard models of investment say that investment demand is a negative function of the existing capital stock, so a war that destroys part of the capital stock causes a rebuilding boom and increases the natural rate of interest when the war ends.

I can only think of one plausible candidate that might work: inflation inertia. If there is inflation inertia, monetary policy still ultimately controls inflation, but the inflation rate has a lot of momentum, so that it's hard to get it to speed up or slow down quickly. If there is sufficient inflation inertia, I might be able to get the Canadian economy stuck in a liquidity trap so badly it would be very hard for anyone else to get it out again.

Suppose I targeted minus 10% inflation, and I eventually hit my target, before they managed to break the locks. If there is inflation inertia, the inflation rate won't immediately go back to 2% when Steve takes over. Just like a car, no matter how powerful the engine, won't accelerate from 0 to 100km/hr in 0 seconds. This means there may be some strictly positive time period during which the ZLB will be a binding constraint on short-term nominal interest rates even after Steve takes over again and everyone knows Steve is back in charge for good. If that is the case, does there exist an equilibrium time-path in which inflation eventually returns to Steve's 2% target? If not, then I have succeeded in getting the Canadian economy irreversibly stuck in a liquidity trap.

The answer isn't obvious. If saving and investment depend only on the short-term real interest rate, and if actual inflation depends only on lagged inflation and current output and short-term expected inflation, then there may not exist an equilibrium time-path in which inflation eventually gets back to Steve's 2% target. Because Steve's forward guidance can influence long-term real interest rates and long-term expected inflation, but these don't matter by assumption. So the short term real interest rate will be above the natural rate for some period, which means output will be below the natural rate for the same period, which means that actual and expected inflation would fall still further during that period, which prolongs the return to the 2% target, and so on. Which means I might be able to get the economy irreversibly stuck.

But is there inflation inertia? The answer to that question isn't obvious either.

There is no inflation inertia in the Calvo Phillips Curve assumed in standard New Keynesian models. If output is at the natural rate, and if expected inflation is at 2%, actual inflation will also be at 2%, regardless of what it was in the past. So if the standard New Keynesian model is true, Steve can reverse what I did and get inflation back to 2% with no lag. But nobody actually believes the Calvo Phillips Curve; we only assume it because it makes it possible to do the math.

Empirically the evidence seems to be mixed, at least to my eyes. During relatively normal times there looks like a lot of inflation inertia. It's just too easy to forecast inflation, especially core inflation, from lagged inflation. But in abnormal times, when there is a clear change in monetary regime that changes expectations, inflation seems to change very quickly. We saw that when the Bank of Canada announced the original inflation targeting agreement. We saw it even more clearly in Sargent's "The ends of four big inflations" (pdf). Dragging me out of the Bank of Canada and putting Steve Poloz back in charge would be a very big and obvious change in monetary regime.

[Update: See Marcus Nunes for another example where apparent inflation inertia suddenly disappeared when the monetary regime changed.]

Dunno. It might be possible to get an economy irreversibly stuck in a liquidity trap. But it's a lot harder than you might think.

Comments

[Kevin Donoghue]

Are we talking about "a situation in which conventional monetary policy — open-market purchases of short-term government debt — has lost effectiveness" (Krugman's definition of a liquidity trap) or something more lethal?

[reason]

It depends HOW you create money. If you only create money by expanding private debt - maybe it is hard to get people to take on extra debt. A proper helicopter drop should work - but is that fiscal or monetary policy?

[Ralph Musgrave]

Robert Mugabwe knows how to come out of liquidity trap at the speed of sound and go too far in the opposite direction. But apparently the West’s so called “professional” economists can’t work it out.

[Nick Rowe]

Kevin: that definition doesn't work, because it is silent on the question of whether those are temporary or permanent open-market purchases of short-term government debt. Just like a helicopter drop needs to be defined as either temporary or permanent. I'm talking about something more lethal than just "temporary OMOs or helicopters won't work".

reason: almost any monetary policy change will change the profits of the central bank, and if the central bank is owned by the government, those profits sooner or later go to the government, which affects the government's budget constraint, which has fiscal consequences. The only degree of freedom is in the timing of those fiscal consequences.

[Nick Rowe]

Ralph: Yep. Remind us again of Mosler's Dictum(?) for those reading this, just add that when Warren says "fiscal policy" he means what we call "money-financed fiscal policy", so he's really (in our language) talking about a permanent increase in the money supply where the government happens to spend all the central bank's extra profits right now.

[Frank Restly]

Nick,

http://en.wikipedia.org/wiki/Liquidity_Trap

"A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth."

A liquidity trap can be said to be a condition where lowering interest rates does not boost (stimulate) credit growth - yes? Ultimately nominal interest rates and nominal economic growth are positively correlated and so there is a trade off between interest rate reductions and hope by the central bank that credit growth rises.

For private credit growth to take hold both the borrower and the lender must be amicable to the terms of the loan agreement. And so a central bank by pushing interest rates too low can destroy the incentive to lend at those rates by the private banking system - Federal Reserve as lender of last resort becomes lender of only resort.

[Ralph Musgrave]

Nick,

What Mosler and I think most MMTers advocate is combining monetary and fiscal policy. I.e. if there’s a recession, then “create $Xbn of new money and spend it (and/or cut taxes).”

I favour that policy. It does have its POLITICAL difficulties, e.g. it can be difficult to reverse (though the cuts in VAT in the UK over the last four years were reversed without difficulty).

Also, given inflation, the real value of the monetary base shrinks at 2%pa (and much more than that in the UK over the last 5 years). So significant amounts of reversal are not normally needed: rather it’s a case of adjusting the rate at which the base in nominal terms increases.

As to “central bank profits”, I don’t think the phrase means much. E.g. the Bank of England created £60bn out of thin air at the height of the crises for the benefit of two banks, RBS and HBOS. Did that add £60bn to the BoE’s “profits”?

[Nick Rowe]

Ralph: "Did that add £60bn to the BoE’s “profits”? "

Yes. Minus the present value of what they lose if and when they destroy that L60bn again, and plus or minus any profits or losses on what they bought with it.

[Kevin Donoghue]

Nick, I'd say conventional monetary policy is always silent on the question of "whether those are temporary or permanent open-market purchases of short-term government debt." Any promise that future policy will depart significantly from past practice is unconventional.

[Philippe]

"when Warren says "fiscal policy" he means what we call "money-financed fiscal policy"

He argues that "bond-financed" fiscal policy isn't necessarily less stimulative than "money financed" fiscal policy, it might even be more stimulative.

[Nick Rowe]

Kevin: maybe, but conventional monetary policy is not usually silent on the long run target, like whether it's an inflation target, for example. Announcing a permanent 10% increase in the money supply, for example (so that M(t) will always be 10% higher than it would otherwise have been, for all t after today) is equivalent to a 10% rise in a price level path target.

Philippe: yep, if you pay the interest on those bonds by printing even more money, as opposed to raising taxes.

[Jon]

It's fascinating that almost no one discusses the possibility that the liquidity trap in the islm model is evidence that the model is wrong. Similar to how the ultraviolet catastrophe was an artifact of rayleigh's law and not physical. We've never seen a liquidity trap happen. Output responded to monetary policy announcements during the depression and it responded during the past five years. Time to start saying the liquidity trap result discredits the old Keynesian models.

[Philippe]

Nick,

He separates the taxing from spending because he argues taxes don't logically fund government spending. What he tends to look at is the overall size of the budget deficit.

[Nick Rowe]

Jon: very good point. I sort of said something a bit like that in this old post on "Why don't we observe black holes?"

[Kevin Donoghue]

"Announcing a permanent 10% increase in the money supply...is equivalent to a 10% rise in a price level path target."

Yes and I don't know anyone who would describe such an announcement as conventional monetary policy.

"We've never seen a liquidity trap happen."

John Quiggin seems pretty sure he saw one a few years back.

http://johnquiggin.com/2013/08/26/a-note-on-the-ineffectiveness-of-monetary-stimulus/

[Kevin Donoghue]

Ah but now JQ is trolling:

"AFAICT, MMT is the idea that the economy is always in a liquidity trap (hence unlimited scope for fiscal policy) while MM is the idea that the Great Moderation is forever (hence, omnipotence of monetary policy). Right now, MMT is closer to the truth."

[Matthew]

Inflation inertia isn't necessary to produce an "irreversible" liquidity trap. If prices are sufficiently sticky relative to the other parameters in the model, then you can end up in an expectations-driven multiple equilibrium scenario where one of the equilibria is a permanent liquidity trap. As you mention, the new keynesian Phillips curve depends on expected short-run inflation, not long run inflation targets, so all is required is a huge amount of price stickiness.

[Frank Restly]

Jon,

"It's fascinating that almost no one discusses the possibility that the liquidity trap in the islm model is evidence that the model is wrong."

Not wrong, just incomplete. Newton wasn't wrong about gravity, he just didn't have the tools to test his theories at very high speeds (special relativity) or in accelerating frames of reference (general relativity).

[Nick Rowe]

Matthew: I'm not sure you are right about that. To my mind, "price stickiness" refers to the *level* of prices. The price *level* cannot adjust quickly to the new equilibrium following a change in monetary policy. The Calvo model has price stickiness in that sense. But the price level isn't relevant for the ZLB. It's the rate of inflation that is relevant for the ZLB. And "inflation inertia" (inflation stickiness) means the inflation rate cannot adjust quickly.

Maybe I'm misunderstanding you?

[Scott Sumner]

Kevin, The period Quiggin discusses Australia was not even close to the zero bound. In addition, he describes a cut in interest rates from 17% to 5% in a period where NGDP growth fell from double digits to one percent as an "expansionary monetary policy" And no, I'm not joking. By the logic the Volcker disinflation (similar interest rate and NGDP data) was an easy money policy!!

http://www.themoneyillusion.com/?p=23215

How would he describe monetary policy during the German hyperinflation? Ultra-tight? My Keynesian commenters kept insisting I was attacking a caricature of Keynesian economics. But it seems the interest rate fallacy is alive and well.

[Philippe]

If the economy is in a depression and the government is running a huge budget deficit, would you describe that as 'tight' fiscal policy? Or 'loose' fiscal policy?

[Karsten Howes]

Nick,

"If output is at the natural rate, and if expected inflation is at 2%, actual inflation will also be at 2%, regardless of what it was in the past. So if the standard New Keynesian model is true, Steve can reverse what I did and get inflation back to 2% with no lag."

I think you are saying that since inflation isn't sticky, it is possible to change it instantly merely by changing the target. I think that's true, but it is not something external to the NK model. The target is explicitly embedded in the policy rule and therefore in the NK Philips curve. So it directly controls current inflation via rational expectations of future policy. As I read your post I get the feeling that you see the target as something that can be set independently of the conditional path of the policy rate (the policy rule). I don't see that.

You have driven the economy into a state of high deflation and high real interest rate. It's not inertia keeping inflation there, but rather it's the unique dynamic equilibrium consistent with the current setting of i and pi, and policy and microstructure-consistent expectations (ratex). There is nothing intrinsically reversible about this dynamic. This stick is falling over, not because it has inertia, but because the bottom is too far to the right (nominal rate) and the top is too far to the left (deflation).

So there is no guarantee that Governor Poloz can reverse the damage you did, but it's not impossible that he can. Within the limits implied by the microstructure of the real economy, the price setting dynamic and the credibility of the available set of policy rules, he can grab the stick by the top and move it a certain amount to the right. If the return of Poloz is a surprise, it produces a sudden regime change, meaning a whole new Philips curve (the Philips curve before will reflect some weighted average of your policy and Poloz's, depending on the perceived probability of breaking the locks). This will cause a jump in the spot inflation rate, which could, if large enough, result in a sudden transition out of the trap.

But I don't see how any of this depends on inertia or any mechanism outside of the microstructure of the standard NK model.

[Mark A. Sadowski]

Nick,
This is completely off topic but I think have some econometric results that may be of interest to you.

A couple of weeks ago I was commenting at UnlearningEconomics:

http://unlearningeconomics.wordpress.com/2013/08/17/market-monetarism-jumps-the-shark/

And the topic of endogenous money and Granger causality came up. I did some googling and apparently the endogenous money people have been blogging about the empirical evidence supposedly supporting endogenous money for the past few months and it has gone to their heads. Most of this research involves Granger causality.

I've been toying with Granger causality, specifically a technigue I read about on David Giles blog invented by Toda and Yamamato. And on a hunch I started running Granger causality tests between the monetary base and broad money during ZIRP episodes involving QE. I've consistently found that monetary base Granger causes broad money but not the other way around. When I brought this up at UnlearningEconomics this was pooh poohed because of all the "empirical evidence supporting endogenous money".

Of course, if a central bank is setting interest rate targets one expects loans to Granger cause the monetary base, and broad money, or the broad money multiplier, which is what some of these studies find (almost all of them are published in the Journal of Post Keynesian Economics). But I've noticed in ZIRP episodes with monetary base expansion (QE) normally there is corresponding broad money expansion which the endogenous money people say is impossible.

Well I've gone a lot further using US data. What I find is that since December 2008 the monetary base Granger causes loans and leases at commercial banks and that the M1, M2 and MZM money multiplier all Granger cause loans and leases (but neither is the other way around). This is exactly the opposite of what Structural Endogeneity predicts.

I'm thinking I should repeat the work on the UK and Japan and possibly the US during the Great Depression. It sounds very interesting to me of course, but who would publish research showing money is not endogenous during QE using endogenous money research techniques?

[Philippe]

"I've noticed in ZIRP episodes with monetary base expansion (QE) normally there is corresponding broad money expansion which the endogenous money people say is impossible."

With QE the central bank buys assets from primary dealers, but these in turn buy them from all sorts of non-bank investors. As such QE directly increases the quantity of bank deposits held by non-banks (broad money), as well as the quantity of bank reserves.

This recent paper details who ultimately sells assets to the Fed as part of QE:

"Overall, our results suggest that the Federal Reserve is ultimately interacting with only a handful of investor types. Households (the group that includes hedge funds), broker-dealers, and insurance companies appear to be the largest sellers of Treasury securities when the Federal Reserve buys these securities. Households, investment companies, and to a lesser extent, pension funds, are the largest sellers of MBS when the Federal Reserve buys. With both the Federal Reserve’s Treasury and MBS purchases, our results suggest that households are the largest, ultimate seller..."

"Analyzing Federal Reserve Asset Purchases: From whom does the Fed buy?" (2013)
http://www.federalreserve.gov/pubs/feds/2013/201332/201332pap.pdf

[Mark A. Sadowski]

"This is exactly the opposite of what Structural Endogeneity predicts."

should read

"This is exactly the opposite of what Accomodative Endogeneity predicts."

[Patrick]

Mark, is Granger causality really applicable? I'm no expert, but it seems to me that whatever the underlying process, it's probably not purely stochastic. After all, Uncle Ben has adjusted the interest rate dial on the machine - so there is a machine of some description.

[W. Peden]

Mark A. Sadowski,

That sounds fascinating!

[Mark A. Sadowski]

Patrick,
"Mark, is Granger causality really applicable? I'm no expert, but it seems to me that whatever the underlying process, it's probably not purely stochastic. After all, Uncle Ben has adjusted the interest rate dial on the machine - so there is a machine of some description."

If you back to Kaldor's 1970-85 papers/books on the subject, and he's probably legitimately the originator of the whole Post Keynesian strand of endogenous money, one of the key points he was making contra Milton Friedman was that money demand is unstable. If money demand is unstable you don't necessarily expect money supply to be the driving nominal variable. Granger causality tests merely confirm that the causality is bidirectional and varies according to time and place, so yes.

Most endogenous money people assume that Market Monetarism (MM), and their associates, are arguing money demand is stable just like Friedman did in the 1960s and 70s. But half a century has passed (Milton Friedman is dead, may he RIP) and yet the endogenous money people are still declaring victory in a war that is no longer being fought. MM et al. is as much, if not more, about money demand but this doesn't seem to get through the thick skulls of most endogenous money enthusiasts.

Accomodative Endogeneity acknowledges that the money creation process is directly run via the central bank's short run interest rate control knob. But they also believe that the economy is a driving force in money demand, and if the central bank fails to accomodate that demand by adjusting the dial the economy will "blow up" (whatever that may mean). Most importantly they also believe that once short run interest rates hit the zero lower bound there is absolutely nothing central banks can do. QE cannot affect loans and it cannot affect money supply (i.e. deposits). And yet the Granger causality tests show this is plainly false.

P.S. There are other schools of money endogeneity, namely Structural and Liquidity Preference. Structural endogneity is highly nuanced and I don't feel up to summarizing their views yet, which to me seem to vary considerably depending on person and time of day. Liquidity Preference merely predicts there is bidirectional causality between loans and money supply which isn't at all controversial to MM et al.

[Patrick]

Thanks the reply Mark, but I was just talking about the applicability of the statistical test from a mathematical point of view. Seems to me the underlying system is likely to be a complex dynamic system, and Granger may not be applicable. Just a thought. I'm certainly no expert.

[Mark A. Sadowski]

Patrick,
"Thanks the reply Mark, but I was just talking about the applicability of the statistical test from a mathematical point of view. Seems to me the underlying system is likely to be a complex dynamic system, and Granger may not be applicable. Just a thought. I'm certainly no expert."

Almost all of the more common criticisms of Granger causality testing are overcome by the Toda and Yamamato vector autoregression (VAR) technique, which is apparently considered state of the art.

However, to be clear, failure to reject the null hypothesis that x does not cause y, does not necessarily mean that there is in fact no causality. A lack of sensitivity could result from too small a sample even if true causation occurs. Furthermore, as its name implies, Granger causality is not necessarily true causality. If both x and y are driven by a common third process, then one might still accept the alternative hypothesis of Granger causality.

[Tom Grey]

I'm very disappointed that so little effort is done to look, quantitatively, at how many loans are given out by lenders (banks, or banks plus others).
Whether it is interest rates or QE, the "tightness" of money is actually how easy or not it is to get a loan. Thus, the measure should be ... how many loans.
Perhaps also how many first loans to a first time borrower.
Perhaps also first time business borrower (prior car & house borrower).

And my own suggested cure: Tax Loans. To any taxpayer who paid taxes, an ARM loan equal to the last 5 years of income tax paid, at the Fed interest rate, adjusted quarterly.

Almost a helicopter loan drop -- but with counter cyclical long term fiscal impact (spend now in financial crisis, pay back in good times reducing any bubble).

[Nick Rowe]

Mark: Interesting. I am very wary of econometric causality tests for a rather different reason: If the central bank is using instrument X to target Y then we ought to find that X does *not* Granger cause Y, even if X does in fact cause Y, unless the central bank is making systematic mistakes. And even if it is making systematic mistakes, the estimated "effect" of X on Y could as easily have a sign opposite the true sign.

My one foray into Granger causality and money is here (pdf). (It got published in JIMF.)

I would fit your results into my perspective as follows: Granger causality tests only reveal true causality when the central bank is screwing up and making purely random moves.

[Nick Rowe]

Karsten: Here's another way of looking at it (I should have said this in the original post):

Does history matter? If history doesn't matter, then as soon as Steve Poloz takes over from Nick, it is exactly the same from then on as if Nick had never grabbed control in the first place.

Now history might matter because Nick leaves a lower capital stock, but that won't prevent Steve escaping the ZLB.

History might also matter if it leaves a higher variance of relative prices across firms, given Calvo pricing and Nick's stupid monetary policy. But I can't see how that makes it harder for Steve to escape.

The only thing I can see is if we ditch calvo pricing so the history of inflation matters.

[Mark A. Sadowski]

Nick,
"I am very wary of econometric causality tests for a rather different reason: If the central bank is using instrument X to target Y then we ought to find that X does *not* Granger cause Y, even if X does in fact cause Y, unless the central bank is making systematic mistakes. And even if it is making systematic mistakes, the estimated "effect" of X on Y could as easily have a sign opposite the true sign."

I'm not sure this is a reason to be wary, it is however a reason to be aware. Unfortunately awareness of how the central bank's targets and instruments affects causality tests seems to be in very short supply among many of the endogenous money enthusiasts.

P.S. I love your paper.

[scepticus]

"Arrow & Fisher (1974) defined an irreversible action as one that is infinitely costly to
reverse" [http://ecoservices.asu.edu/pdf/Perrings%20and%20Brock,%20ARRE%20(2009).pdf]

It is possible to imagine, in theory, reversing actions that would be totally impossible in practice. The costs of reversing an economic action at the macro level may be constrained by many things. For example, if a decision is taken to convert various stored up problems in a financial system into a general inflation or an increase in the stock of money then reversing those actions are constrained, possibly, by things like the zero lower bound and the political possibilities of negative real rates.

The paper above identifies three types of irreversibility:

- "the technical irreversibility of investment decisions lies in the forgone future opportunities
- "irreversibility in the context of the stability properties of different states. Transition
to an absorbing state is irreversible. Transition to a persistent state may be slowly
reversible. More generally, the degree to which transition to some state is irreversible is
implicitly measured by the resilience of the system in that state."
- "the phenomena
recognized in economics as “lock-in” or “lock-out” are special cases of a more general
property of complex dynamical systems—that their future is entrained by their past.
Feedback effects serve to entrench or exclude some technologies or social processes, at
least for a time."

Which one of the above are you talking about in this post? I guess its the second one?

[Nick Rowe]

scepticus: I think it's the second one too.

[scepticus]

"During relatively normal times there looks like a lot of inflation inertia. It's just too easy to forecast inflation, especially core inflation, from lagged inflation. But in abnormal times, when there is a clear change in monetary regime that changes expectations, inflation seems to change very quickly."

Having clarified that its the second regime you are referring to, the above passage seems to refer to 'critical slowing down'. Critical slowing down (the time it takes for a system to return to its stable configuration following a perturbation which it resists, with the transition-vulnerable system exhibiting longer time to return to the previous trend).

I don't know much about Granger Causality but I guess it must relate to autocorrelation (where autocorrelation increases with critical slowing down to the transition point).

Anyway, a system with high inflation inertia is one that is prone to return to trend (the previous, existing equilibria) and is thus not exhiniting critical slowing down and is not in danger of an irrevesible transition. It doesn't need much nudge from monetary policy to do so. If the evidence shows that we have a period of little inflation inertia, that means the transition point is closer, as per the science of phase transitions, complex systems etc.

That suggests that when inflation inertia is high, reversibility is more likely, not less. When inflation inertia is very low, any significant policy action would in theory run more risk of causing a transition to some new equilibria from which it may be impossible to return.

That said, if you look at the 19th century the gold standard then was a stable attractor with considerable resilience but inflation and short term rates were much more volatile than they have been in previous decades. I guess the usefulness of inflation volatility as an indicator of possible reversibility depends very much on which equilibria/regime one happens to reside - it would not have been much use in the 19th century.

[Steve Roth]

On Marcus's Brazil example: This American Life had a brilliant “The Invention of Money” episode that described it, including interviews with the people who engineered it.

I condense the TAL episode takeaway at the end of this post:

http://www.asymptosis.com/medium-of-account-vs-unit-of-account-brazil-anyone.html

Wherein I also think hard about units/media of account and exchange, among other things coming to a very similar conclusion as JP Koning:

JP: "I think that the current medium of account is CPI units."
http://jpkoning.blogspot.com/2012/11/discussions-of-medium-of-account-could.html

Moi: "the medium of account is always value"

Ooh yuck that word.

I was kind of astounded when I wrote it to find that monetarists thinkers (bloggers at least) have barely written about the Brazil episode, often aren't even aware of it -- especially astounded given the rather gobsmacking chart of Brazilian inflation that Marcus posts.

[Edward Lambert]

Nick, I know you don't appreciate my work but there is another way to get stuck in the zero lower bound, and the Fed is powerless to get out. Just lower the labor share of income.
Here is a link to an old post with an equation that has changed since, but the idea is there.
http://effectivedemand.typepad.com/ed/2013/05/the-autopsy-of-the-fed-funds-rate.html

[Nick Rowe]

Edward: if you assume that workers have a higher mpc than capitalists, then (under certain other assumptions, because it depends on how that would affect investment demand too) a reduction in the labour share of income *might* lower the natural rate of interest. But that does not mean that the central bank is powerless to take offsetting action to prevent hitting the ZLB. For example, it could simply raise the inflation target.

See that bit in my post where I said: "If monetary policy were loose enough, you would never get into a liquidity trap in the first place. The Zero Lower Bound on nominal interest rates won't be a constraint, for any conceivable shock, if you are targeting 100% inflation. Hitting the ZLB means you were running too tight a monetary policy, given the driving conditions, in the first place."?

Did you read that bit? Did you understand it?

Look I know you are really really keen for everyone to read your work. (We are all a bit like that; it's the bloggers' sin). But when you jump into all other conversations, just saying "read my stuff!" and adding a link to your blog posts, with all appearances of being deaf to the conversation going on around you, and not having made any attempt to read others' stuff or understand it, it does get a bit irritating. Because it's not just here you are doing that. And it makes people even less inclined to read your stuff. Because there's lots of stuff out there competing for our attention, and someone who has read and understood others' stuff, and who still thinks he might have something useful to say, is more likely to be right than someone who hasn't.

[Nick Rowe]

Steve: "I was kind of astounded when I wrote it to find that monetarists thinkers (bloggers at least) have barely written about the Brazil episode, often aren't even aware of it -- especially astounded given the rather gobsmacking chart of Brazilian inflation that Marcus posts."

I think that's a fair point. And it's good that Marcus raised that Brazilian point too.

But actually, I think that bloggers, and especially MM bloggers, are much less guilty than most in one very important respect. Me and Scott Sumner actually argue about which is most important: MOE or MOA functions of money? That whole distinction is one that gets very little attention. For example, when New Keynesian macroeconomists talk about "monetary policy" are they talking about MOE or MOA policy?

(I wrote a draft post on this topic a few days back, but it's not coming out right yet.)

[Kristjan]

Ralph: Yep. Remind us again of Mosler's Dictum(?) for those reading this, just add that when Warren says "fiscal policy" he means what we call "money-financed fiscal policy", so he's really (in our language) talking about a permanent increase in the money supply where the government happens to spend all the central bank's extra profits right now.

I don't think you got Mosler quite right Nick unless I'm misunerstanding you. I think for Mosler there is no meaning for central bank's profit other than for accounting clarity. He consolidetes central bank treasury balance sheets and calls It all government. it's government money machine to him (the last expression is mine). So he sees central bank higher profit functionally the same as higher net taxes. Your thinking is totally out of paradigm for any MMTer, you think like a monetarist.
You get higher profits for central bank, the more private sector net financial assets are destroyed and government has no budget constraint.

[Doug M]

It is very hard to get a car truly and permanently stuck. You just need the right tools to get it un-stuck. And permanent, only in the sense that you still want your car to function. Really there is not a trap deep enough, that someone couldn't cut your car into pieces and get the car out.

But there are lots of ways to get a car stuck that will require some effort and maybe big tools.

So, to get the economy stuck...we can't talk about permanently stuck... but we can talk about stubbornly unresponsive...

Merely tightening money doesn't get the economy stuck. You raise short term rates, and they can be lowered. You increase mandatory bank reserves, and that policy can be reversed. You need money supply to crash while every standard tool of money manipulation is set to easy.

First you need to create the environment when people "over-leverage"? But what is over-leverage. For any degree of risk there is a maximum degree of leverage beyond which increasing leverage does not increase ones expected return. To make people over-leverage you must lower the perception of risk. If volatility stays low enough long enough, it appear rational to lever your book 40x. Then you gradually ease the conventional levels of money supply to make it cheap to lever 40x. Then you need a shock, to make people realize how insane their positions are. The rest will take care of itself. A few people will be wiped out by the shock. Their creditors take a hit, and they call in the loans to others that were damaged but not necessarily dead. This drying up of liquidity pushes the barely alive over the cliff. etc.

We have wiped away the value of financial assets. There is really very little the central bank can do restore value to these assets.

But the funny thing about this, is that not a single real asset was affected. There are the same factories and workers and service professionals. But, without the money-men directing the cash flow work comes to a halt.

[Tom Brown]

Nick, I see you mention MOA and MOA, but what about UOA?

[Tom Brown]

Shoot! replace one MOA above with MOE.

[notsneaky]

This might have already been said in the comments above(which I just can't make myself read) but... aren't you confusing a shift of a particular curve with a movement along a particular curve? Tight monetary policy doesn't get you into a liquidity trap. An exogenous (real) demand side shock (a shift of the IS curve) does. Of course, successful tight monetary policy which results in near zero inflation means that it takes a smaller exogenous shock (a shift) to get into the trap, but that's a different thing. And it's why you can't just "reverse it", monetary policy wise, except to the extent that just maybe if you "commit to irresponsible monetary policy" you can substitute higher inflationary expectations for bad animal spirits.

I don't know about this car analogy. But let's go with it. It's sort of like if, for whatever reason, you like to keep your fuel gauge near zero, with the little red light on (maybe because you think it makes you drive in a more efficient, fuel conserving, manner or something). Then an exogenous shocks happens: unexpectedly you find yourself on a long stretch of a road where there's no gas stations on any exit. And then you're out of marshmallows. At that point you can't say "from now I'll drive with more spare gas in my tank" and have the car magically start again. That's the irreversibility, the trap. You need to somehow undue to the exogenous shock, get more gas in the tank, then worry about the other stuff.

Like I said, I'm not sure if this car analogy is appropriate but at least it should be gotten right. Fortunately, liquidity trap recessions are not quite like running out of fuel because you were trying too hard to conserve your gas. There's a spare can of gas in your trunk called fiscal policy (maybe). It's low grade, diluted with alcohol, environmentally unsound, and half evaporated anyway, but at least it will get you to the next gas station where you can fill up on the real stuff.

(There is some pertinent points and loose ends here though. You'd expect that countries with lower inflation targets fall into the trap more often but is that the case empirically? Are negative supply side shocks really expansionary in a liquidity trap? Do the ZLB models imply a deflationary spiral? Is there such a thing as a NADRU? But that's beyond the scope of this particular comment and post)

[Nick Rowe]

notsneaky: what caused the accident: the sharp bend in the road; or my driving too fast for the bendy road? And if the car is undamaged (if there's no irreversibility) we can just switch drivers to a slower driver and get out of the ditch, and stay out of it.

[notsneaky]

Nick: If the ditch is deep enough - a trap - you gonna need a tow truck - fiscal policy - to get you out, regardless of how careful the new driver is. The problem with this version of the analogy is that this would apply to all recessions, not just ZLB ones, unless somehow the depth of the ditch and your prior speed are related.

[dlr]

Aside from being late, this answer could be argued to be semantic. But I think it invokes a useful way to talk about liquidity traps. You ask whether inflation inertia or whether 'history matters' might be the only tree stumps we can come up with. Yet these can be thought of as minor components, with many possible friends, to the real culprit, which sadly has to be called credibility.

Chuck Norris can kick Nick Rowe out of the CB. He can exile Nick to Pluto and wipe all citizens' memories of the incident, or even of the recent inflation experience given the right future version of Google Glass. Now history doesn't matter, at least in the proximate sense. No more inertia. Yet it may be a much taller order for Chuck to guarantee that a sunspot tight money acolyte doesn't storm the CB 5, 10 or 20 years hence. Instead of some strange hyper-stylized story about ST rates causing all savings and investment decisions, you keep LT rates in charge as they surely ought to be but simply lose the duration of the CB reaction function. History (in the narrow sense, i.e. a recent regime of tight money) and intense inertia are just two ways to perhaps get stuck in a credibility trap, but require no regime change offset. There are others, including some that have "regime-change" defense built it: Maybe the winds of political change as a fallout from a tight-money amplified recession start to shift toward a party or even future leader that is likely to make a huge mistake in appointing a future CB head, or directly change the CB mandate and prerogative for the (tight-money) worse, years down the road. Or, maybe people are wiped clean of both the Rowe regime and the deflation it produced, but do remember one thing they learned during this time: previously unknown public opinion has been uncovered: people and pundits fear and blame politicians for excessive inflation, bubbles, and pretty much anything unorthodox to such a degree that their worries remains stalwart even when a nominal sledgehammer is pounding the economy. This is the reaction function beneath the reaction function.

Is it unrealistic to worry about the "next" regime change, when some (most??) don't even seem to think that expectations about contingent future policy matter much in the first place? It is definitely hard. Harder than a more hydraulic story like an "inertia" that overpowers a very long duration path of conditional expectations about the future supply of money relative to demand. But unlike inertia, it could be much "more" irreversible if it requires institutional changes that are either impossible, unlikely or too costly to cure.

[Tom Brown]

Mark, I don't know all the difference between these two (aside from your descriptions here):

"Structural Endogeneity"
"Accomodative Endogeneity"

But I've never heard anyone (including what you might call "endogenous people") dispute what Philippe referred to here:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/08/how-can-you-get-an-economy-into-a-liquidity-trap.html?cid=6a00d83451688169e2019aff1eee5d970d#comment-6a00d83451688169e2019aff1eee5d970d

i.e. that with QE (ZLB conditions) deposits grow in the non-bank private sector since they were swapped for Tsy debt. I had the impression that everyone agrees that "QE is an asset swap." Is my perception wrong?

[jb]

I enjoyed reading this post.
Although I reckon a maritime metaphor would be even more fitting( navigating in shallow waters, turning supertankers etc.)
But it's your blog, so I go with the vehicular thingy.

[Nathanael]

"someone else couldn't get it back out of that same liquidity trap just by reversing whatever it is you were doing?"

Set up an asymmetrical governmental system, so that you need only 41 Senate votes *or* a House majority to *cut* the deficit, but you need 61 Senate votes *and* a House majority to raise the deficit or print money.

Yes, this is a US-specific answer, but it's very straightfoward as an answer. You can create a trap by making it impossible to reverse policy.

OK, now for the more economics oriented part of this. I do not believe that "lending policy" (so-called monetary policy) is sufficient to manage an economy. While it is always true that you can escape a liquidity trap with *fiscal* policy, you may easily get into a situation where "monetary policy" cannot fix things.

You get into that situation with policies other than "monetary policy" -- and you have to get out of it with policies other than "monetary policy". However, policies other than "monetary policy" may be *very hard to reverse*.

[Mark A. Sadowski]

Tom Brown,
But I've never heard anyone (including what you might call "endogenous people") dispute what Philippe referred to here:...i.e. that with QE (ZLB conditions) deposits grow in the non-bank private sector since they were swapped for Tsy debt...Is my perception wrong?"

Very much so.

There is a widespread delusion, particulaarly among endogenous money advocates, that QE does nothing to alter broad money supply. They think it goes straight into reserve balances. Of course the only way this can occur is if banks are the only sellers of Treasury and Agency securities to the Fed.

But banks only held about 4.6% of the non-intragovernmental Treasuries not held by the Federal Reserve at the end of 2013Q1, and precise figures are not available for Agency securities, but if the distribution of Agency securities within the financial sector (mutual funds, banks, insurance companies, pension funds etc.) is similar to that of Treasuries then banks likely hold only about a sixth of Agency securities not held by the Fed. Thus the study Philippe cites only confirms what commonsense already strongly suggested.

[Tom Brown]

Mark, good to know. I guess I'd always thought "what commonsense already strongly suggested" (as you say) but I got that (correct) information from Cullen Roche and JKH primarily. The 4.6% figure you quote here is in agreement with Roche's estimate. And prior to that he'd simply written off bank held Tsy debt as insignificant. I guess I just never encountered people that thought otherwise, so your statement here:

"I've noticed in ZIRP episodes with monetary base expansion (QE) normally there is corresponding broad money expansion which the endogenous money people say is impossible."

was an over-generalization (especially since I think Philippe might be an "endogenous money person" as well). One thing that you wrote that confuses me though: if the distribution of Agency securities within the financial sector is similar to that of Treasuries then why do you say this is about 1/6 of the non-Fed total of these securities rather than 4.6%? If you're assuming a similar distribution, why the difference?

[Tom Brown]

... and I'm not sure what "endogenous money people" are, but both Nick Rowe and Scott Sumner are in this category too given a central bank targeting something else,... at least at the "structural" level, if I get your meaning there correct:

"Under inflation targeting the quantity of money is endogenous in both the short run and the long run. It's the nominal rate of interest that is exogenous in the very short run (6 weeks or less, for the Bank of Canada anyway), but endogenous in the long run." - Nick Rowe

http://brown-blog-5.blogspot.com/p/links-to-remember.html

"In a sensible system the base money is endogenous. You set the NGDP target, and the public tells you how much base money they want to hold. I’m all for that." - Scott Sumner

http://www.themoneyillusion.com/?p=22948#comment-267116

Scott also indicates that he agrees with Nick's quote above:

http://www.themoneyillusion.com/?p=23186#comment-271999

and of course Nick again (actually, this was in response to you Mark):

"Couldn't someone believe all these 3 things: commercial banks create money; the amount they create (generally) depends both on what the central bank does and on other things too (so it's endogenous in that sense); monetary policy is effective? I believe all those 3 things!"

http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/04/monetary-policy-is-just-one-damn-interest-rate-after-another.html

I'm perfectly aware that the central bank can do as it pleases... and if it wants to target base money stock as an exogenous variable, then it certainly can. No doubt Nick and Scott would agree with that, but then who wouldn't? Again, maybe I don't see it, but I don't know anybody that would say otherwise (maybe I don't get out much!). Is that what you're getting at with your "structural" vs "accommodative" sub-categories of "endogenous people?" If Nick and Scott are in the "structural" camp with their statements here, I guess I would be too.

[Mark A. Sadowski]

Tom Brown,
"One thing that you wrote that confuses me though: if the distribution of Agency securities within the financial sector is similar to that of Treasuries then why do you say this is about 1/6 of the non-Fed total of these securities rather than 4.6%? If you're assuming a similar distribution, why the difference?"

That's because the financial sector holds a much larger share of the Agency securities not held by the Federal Reserve than it does the Treasuries. The financial sector (mutual funds, banking institutions, insurance companies and pension funds) held 24.2% of all Treasury securities not held by the Fed at the end of 2013Q1. In contrast the financial sector held 77.1% of all Agency securities not held by the Fed at the end of 2012Q4.

"I'm perfectly aware that the central bank can do as it pleases... and if it wants to target base money stock as an exogenous variable, then it certainly can. No doubt Nick and Scott would agree with that, but then who wouldn't? Again, maybe I don't see it, but I don't know anybody that would say otherwise (maybe I don't get out much!). Is that what you're getting at with your "structural" vs "accommodative" sub-categories of "endogenous people?" If Nick and Scott are in the "structural" camp with their statements here, I guess I would be too."

I gave a quick and dirty summary here:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/08/how-can-you-get-an-economy-into-a-liquidity-trap.html?cid=6a00d83451688169e2019aff20aa92970d#comment-6a00d83451688169e2019aff20aa92970d

The modern strand of endogenous money theory has its roots in the old Nicholas Kaldor rants against poor old Milton Friedman of the 1970s and early 1980s. It's entirely a Post Keynesian/MMT/MR project and if you read between the lines the whole point of it is simply to prove that monetary policy is impotent.

Fundamentally if you truly believe in "endogenous money" you believe monetary policy is an effect, not a cause. There is of course no such thing as "exogenous money" school although the endogenous money people like to pretend that there is, and do all they can to encourage people to believe in mischaracterizations of what non-endogenous money people actually believe (this includes Cullen Roche). So they carefully construct an exogenous money strawman complete with a series of erroneous beliefs to rail against, similar to what Nicholas Kaldor did 40 years ago.

Thus I would not describe Rowe or Sumner as believers in Structural Endogeneity because that is a strand of Post Keynesian thought that is fundamentally antithetical to the whole Market Monetarist project.

A nice little summary of the subsects of the different endogenous money schools of thought can be found in Table 1 of this paper (unfortunately I cannot find a free copy):

http://ideas.repec.org/a/mes/postke/v25y2003i4p599-611.html

If I had to identify the different endogenous money schools of thought with economists, I would say Accomodative Endogeneity is represented by Basil Moore, Structural Endogeneity by Thomas Palley and Robert Pollin, and Liquidity Preference by Peter Howells.

[Mark A. Sadowski]

Tom Brown,
"One thing that you wrote that confuses me though: if the distribution of Agency securities within the financial sector is similar to that of Treasuries then why do you say this is about 1/6 of the non-Fed total of these securities rather than 4.6%? If you're assuming a similar distribution, why the difference?"

Because the financial sector holds a much larger proportion of the Agency securities not held by the Federal Reserve than it does of the Treasuries not held by the Fed.

At the end of 2013Q1 the financial sector (mutual funds, banking isntitutions, insurance companies and pension funds) held 24.1% of Treasuries not held by the Fed. In comparison at the end of 2012Q4 the financial sector held 77.1% of all Agency securities not held by teh Fed.

[Mark A. Sadowski]

Tom Brown,
"I'm perfectly aware that the central bank can do as it pleases... and if it wants to target base money stock as an exogenous variable, then it certainly can. No doubt Nick and Scott would agree with that, but then who wouldn't? Again, maybe I don't see it, but I don't know anybody that would say otherwise (maybe I don't get out much!). Is that what you're getting at with your "structural" vs "accommodative" sub-categories of "endogenous people?" If Nick and Scott are in the "structural" camp with their statements here, I guess I would be too."

I gave a quick and dirty but fairly complete comprehensive summary here:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/08/how-can-you-get-an-economy-into-a-liquidity-trap.html?cid=6a00d83451688169e2019aff20aa92970d#comment-6a00d83451688169e2019aff20aa92970d

The current thread of endogenous money theory traces its origins to the Nicholas Kaldor bitchy rants against poor old Milton Friedman of the 1970s and early 1980s. It is almost entirely a Post Keynesian/MMT/MR phenomenon, and implicitly the whole point of the endogenous money project is to somehow prove that monetary policy is completely and utterly impotent. If you truly believe in endogenous money you believe that monetary policy is an effect and not a cause (hence it is "endogenous").

Note that there is no "exogenous money" camp. Thus the believers in endogenous money have carefully constructed an exogenous money strawman, complete with a series of erroneous beliefs and nonexistent defective textbooks, so that they could have something to verbally abuse and physically beat up in socially binding demonstrations of rage.

Thus, since Scott Sumner and Nick Rowe are not Post Keynesian/MMT/MR, and they do not believe that monetary policy is always and everywhere completely impotent, I would not describe them as believers in Structural Endogeneity.

A good summary of the main schools of endogenous money can be found in Table 1 of this paper (sorry no free copy):

http://ideas.repec.org/a/mes/postke/v25y2003i4p599-611.html

If I had to identify the different schools of endogenous money with a particular economist I would say Accomodative Endogeneity is represented by Basil Moore, Structural Endogeneity by Robert Pollin and Thomas Palley, and Liquidity preference by Peter Howell.

[Mark A. Sadowski]

Tom Brown,
"I'm perfectly aware that the central bank can do as it pleases... and if it wants to target base money stock as an exogenous variable, then it certainly can. No doubt Nick and Scott would agree with that, but then who wouldn't? Again, maybe I don't see it, but I don't know anybody that would say otherwise (maybe I don't get out much!). Is that what you're getting at with your "structural" vs "accommodative" sub-categories of "endogenous people?" If Nick and Scott are in the "structural" camp with their statements here, I guess I would be too."

I gave a quick and dirty but fairly complete comprehensive summary here:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/08/how-can-you-get-an-economy-into-a-liquidity-trap.html?cid=6a00d83451688169e2019aff20aa92970d#comment-6a00d83451688169e2019aff20aa92970d

The current thread of endogenous money theory traces its origins to the Nicholas Kaldor bitchy rants against poor old Milton Friedman of the 1970s and early 1980s. It is almost entirely a Post Keynesian/MMT/MR phenomenon, and implicitly the whole point of the endogenous money project is to somehow prove that monetary policy is completely and utterly impotent. If you truly believe in endogenous money you believe that monetary policy is an effect and not a cause (hence it is "endogenous").

Note that there is no "exogenous money" camp. Thus the believers in endogenous money have carefully constructed an exogenous money strawman, complete with a series of erroneous beliefs and nonexistent defective textbooks, so that they could have something to verbally abuse and physically beat up in socially binding demonstrations of rage.

Thus, since Scott Sumner and Nick Rowe are not Post Keynesian/MMT/MR, and they do not believe that monetary policy is always and everywhere completely impotent, I would not describe them as believers in Structural Endogeneity.

A good summary of the main schools of endogenous money can be found in Table 1 of this paper:

The Endogenous Money Hypothesis: Empirical Evidence from Malaysia (1985-2000)
Bala Shanmugam, Mahendhiran Nair and Ong Wee Li
Journal of Post Keynesian Economics
Vol. 25, No. 4 (Summer, 2003), pp. 599-611

If I had to identify the different schools of endogenous money with a particular economist I would say Accomodative Endogeneity is represented by Basil Moore, Structural Endogeneity by Robert Pollin and Thomas Palley, and Liquidity preference by Peter Howell.

[Mark A. Sadowski]

Hmmm. Neat. Different versions of the same comment.

[Mark: I had to fish one out of the spam filter (which has been playing up a lot recently). It's OK if it's a bit of a duplicate. But I can't leave it in spam, because it would then think all your comments belong in spam, and on all Typepad blogs. Which they most certainly don't, because you are the best econoblog commenter out there. NR]

[Nick Edmonds]

Mark,

As I recall it, the issue Kaldor was addressing was the direction of causation in the quantity theory. His claim was that rather than M causing PY, both were caused by credit.

Now it seems that there are people who claim to believe in "endogenous money" who understand it to mean simply the idea that the money supply is determined principally by bank lending and are quite happy then with the causal direction of M to PY. They certainly seem to me to be attacking a straw man. But in the 70s and 80s, I'm pretty sure everyone understood the relationship between loans and money, so it wasn't really an issue. I studied my economics in the early 80s and I remember learning it as part of the practicalities of monetarism. Endogenous money, as I understood it, was purely to do with whether it was correct to see money as the independent variable in the quantity theory.

Also, I have to agree with Tom's earlier comment. I was quite surprised to hear of endogenous money advocates claiming that QE would not increase broad money. I'm sure there are some that don't really understand it, but I thought the issue was about the impact on lending not money.

[Mark A. Sadowski]

Nick Edmonds,
"Endogenous money, as I understood it, was purely to do with whether it was correct to see money as the independent variable in the quantity theory."

As put forth originally by Nicholas Kaldor, endogenous money went further than that. It claimed that the level of economic activity (as well as the exchange rate) could be much more reliably and predictably determined by fiscal policy than monetary policy.

"I was quite surprised to hear of endogenous money advocates claiming that QE would not increase broad money. I'm sure there are some that don't really understand it, but I thought the issue was about the impact on lending not money."

I've been unequivocably told numerous times by endogenous money advocates that QE cannot affect the quantity of broad money. In fact I was more or less told precisely this only about three weeks ago by Unlearning Economics who apparently claims to be something of an expert on endogenous money. Moreover this is completely consistent with Accomodationist Endogeneity which claims the direction of causality is strictly from credit to the monetary base.

[Nick Edmonds]

Mark,

Re the Unlearning Economics comment, was that on the "Market Monetarism Jumps the Shark" thread? I had a look through, but I couldn't see where that was discussed. Do you have a comment reference number? I'm not interested in defending one camp against another, but I'm intrigued as to what the reasoning was there. Thanks.

[Mark A. Sadowski]

Nick Edmonds,
"Do you have a comment reference number?"

Peter P. first brought up the issue of endogeneity in comment #37 and that thread is strictly a conversation between me and Peter P.

Then at comment #67 Unleaarning Economics chimes in:

"In any case, even with a clear correlation I would have this down as an issue of reverse causality, which PeterP has pointed out. I adhere to endogenous money theory, where high income results in loan expansions, and the central bank accommodates the growth in the money base. This means that income and reserves will soar at the same time, but not that the latter is causing the former. Further, it is not inconsistent with the idea that the central bank or government placing restrictions on the issuance of bank reserves will cause problems, as happened in the US in 1937, in Japan and so forth."

And that thread is a conversation strictly between me and UE (although I now see Philippe threw in some unnecessary snark at a later date).

Then at comment #86 Unlearning Economics made his/her "last comment" to which I did not respond:

"This causality issue is really the crux of what’s going on. I actually don’t know of any studies that found causality from the money base to the broader money supply; only Kaldor, Kydland & Prescott and numerous endogenous money papers which find it the other way. As I’ve said: the endogenous money story is not inconsistent with there being some effect on the economy from a large MB expansion, as this will make the interbank market more liquid. However, there is a saturation point."

This last point seems to concede that monetary base expansion may somehow have an effect on the economy and hence on broad money through bank lending. But UE also seems to be asserting that QE only has direct influence on reserve balances, and no direct influence at all on deposits.

I would like to continue that conversation at a future point because:

1) I've done much further econometric analysis on the US QEs that in my opinion conclusively refutes the idea that QE has no effect on broad money and bank lending.
2) I've done considerable reading on the issue since, and the Kaldor and Kydland & Prescott papers that he cites need addressing. Kaldor presents no econometric evidence whatsoever in any of his papers/books. And the 1990 Kydland & Prescott paper used an econometric technique on money that has been used this way five times since, twice by Kydland and Gavin (1995 & 2000), twice by Cooley and Hansen (1995 & 1997) and once by Bergman, Bordo and Jonung (1998). In particular Kydland's later papers reach far less extreme conclusions, and Bordo and Jonung are old school Monetarists who obviously don't agree with the central premise of endogenous money theory.
3) From my conversations with Cullen Roche it appears that the Monetary Realists at least acknowledge that QE can increase broad money. So there is clear disagreement within the endogenous money camp.

[Nick Edmonds]

Mark,

Thanks

I can't really speak for them, but one point I would make is that the increase in broad money that definitely does occur with QE (being the money that is paid to the non-bank sellers of bonds) isn't really caused by the increase in reserves - there really both caused by the same thing, i.e. the sale of bonds. So understanding that QE increases broad money doesn't imply any views about the causal direction between reserves and broad money.

[Mark A. Sadowski]

Nick Edmonds,
"So understanding that QE increases broad money doesn't imply any views about the causal direction between reserves and broad money."

That's true, although I have checked the very same links that the Post Keynesian endogenous money research typically does in their Granger causality analysis, namely those between monetary base and bank credit, between bank credit and money supply, and between bank credit and the money multiplier. What I find is that, since December 2008, the monetary base Granger causes loans and leases at commercial banks and that the M1, M2 and MZM money multiplier each Granger cause loans and leases. Furthermore neither of these things is the other way around, which is exactly the opposite of what Accomodative Endogeneity predicts.

The monetary base is obviously not the same as reserve balances, but changes in currency in circulation are generally very gradual, so almost all of the between month changes in the monetary base during the QEs are reflected in changes in reserve balances. Thus I'm confident that were I to check, I would find that (since December 2008) reserve balances also Granger causes loans and leases at commercial banks.

P.S. In my Granger causality analysis I am using the technique developed by Toda and Yamamato.

[Tom Brown]

Mark, thanks for the explanation of your statement regarding agency debt and the different schools of thought on endogeneity.

[Tom Brown]

"implicitly the whole point of the endogenous money project is to somehow prove that monetary policy is completely and utterly impotent. If you truly believe in endogenous money you believe that monetary policy is an effect and not a cause (hence it is "endogenous")."

As a frequent reader of Roche's blog, I have to say I've never seen him claim that "monetary policy is completely and utterly impotent." Lol

I can't speak for the others. I don't really see a conflict in fact between (what I understand of) the Rowe/Sumner view and the Roche view: Rowe/Sumner seem to indicate that when the CB is targeting something, like inflation, for example, that that puts the actions of the CB in a feedback loop (did't Milton Friedman claim the CB's decisions could be made by a computer?). With feedback loops it's hard to say what's a cause and what's an effect (to my understanding anyway... sorry, but I come from a feedback control systems engineering perspective here... not econ, so I admit I'm out of my element!). Now I'll have to go look up what Granger causality is... :D

[W. Peden]

Mark A. Sadowski,

I'm not surprised that Kaldor doesn't offer econometric evidence for his (very unrealistic) endogenous money theory. Tim Congdon (in "Keynes, the Keynesians and Monetarism") does a simple statistical test that proves that Kaldorian endogenous money doesn't pass the first hurdle of stylized facts.

[Mark A. Sadowski]

@Tom Brown,
If you read my comments in this thread I've already covered most of these issues. It's important to separate endogenous money as a simple statement about which variables are endogenous or exogenous depending on what central banks are doing, from Endogenous Money as an economic ideology with a political agenda. That's why I phrased it as extremely as I did, so it's memorable.

My biggest beef against Cullen Roche is his blatant use of half truths and outright lies. For example there is his regular as clockwork references to the failure of QE in the eurozone. The ECB has never done QE, nor does it have any plans to do QE, and he knows this. That's just a sample.

I also have noticed that a handful of his regular commenters are what I would describe as habitual liars, propagandists and libelists. They make Morgan Warstler look like an innocent naive.

@W. Peden,
Is the "simple statistical test" anything like this?

http://www.imr-ltd.com/graphics/recentresearch/article68.pdf

I am also intrigued by Congdon's discussion of Keynes' followers betrayal of Keynes in the immediate postwar period, and Congdon's takedown of the "Keynesian Revolution" myth. It looks very interesting.

[Tom Brown]

"I also have noticed that a handful of his regular commenters are what I would describe as habitual liars, propagandists and libelists."

Shoot! I hope you're not including me in that!... if you are, I hope you'd let me know. Of course you can't hold people's commentators against them. Sumner has some crackpots himself.

Regarding failure of QE in the Eurozone... ...I guess I only read the articles that interest me (and maybe those didn't!), but I have to say I can't remember ever reading a single article on that. Do you have examples? I searched for "Eurozone QE" in his search box but didn't come up with much. When you say "clockwork" just how frequently are you talking about? He does ones on rail traffic like clockwork! Those are a weekly or bi-weekly subject matter.

[Mark A. Sadowski]

Tom Brown,
"I hope you're not including me in that!"

On the contrary, everything I've read written by you has been true and fair.

"Of course you can't hold people's commentators against them."

True, but it's often revealing.

"Sumner has some crackpots himself."

Yes, but they don't usually agree with him. Geoff (aka "Major Freedom") is clearly Sumner's most crazy regular commenter and he's rabidly anti-MM. And although Morgan Warstler may agree with Sumner on many things, he clearly has his own truly bizarre agenda, and in my opinion he has actually done more to hurt Sumner's cause than any other single crackpot.

"Do you have examples?"

Sure, here's a couple of recent ones:

1) Chart of the Day: Corporate Profits vs the S&P 500 - April 11,2013

"I’ve made a big fuss over QE in recent years and yet the market continues to plough higher. I often have people ask me:

“Why does QE make stock prices go higher if there’s no fundamental impact?”

My answer is always the same. First, look at Europe where QE has also been implemented and stock markets like Greece, Italy and Spain have been decimated. Then look at a country like the USA where QE has been implemented and yet stocks soar. Then ask yourself what the big difference is between these countries? The answer: austerity versus massive deficit spending..."

I commented there and at that time it still wasn't clear to me that the ECB hadn't done any QE as I was still getting a handle on ECB monetary policy, so I made no issue of it. But that claim is still outright nonsense if you read my response.

2) Quite the QE Conundrum…. - August 13, 2013

"One thing I’ve continually cited throughout Quantitative Easing is how the evidence between stock prices and QE is actually much less reliable than most presume. The case I keep pointing to is Europe where the ECB’s balance sheet expansion has coincided with many markets crashing (like the periphery stock markets)..."

In that one I actually laid out the evidence that the ECB has done no QE. The only response was from "anonymous" who makes a claim I had already addressed in my comment and that is flatly false.

As Cullen himself says, "My answer is always the same. First, look at Europe where QE has also been implemented..."

So, feel free to google for more.

[Tom Brown]

Mark, thanks for your response. I'll check into it. I saw one of those articles but missed the QE part (except for in the title). I'm glad you don't put me on that list. As for Geoff being "Major Freedom"... Wow! I should have guessed... I was going to specify Geoff by name, but refrained. OK, thanks for the good conversation. But quite honestly I've always found Cullen to be open to changing his view should new info come to light. Thanks again!

[Tom Brown]

"True and fair" ... now I'm sure I haven't lived up to those standards... maybe fair.. I always strive for that, but I'm quite sure I've written some things that weren't true (that I learned were not true later). I'm glad you didn't see them! :D

As for crackpots... there certainly are some deranged people out there! But not just madness... I think there are problems with memory and learning disabilities... maybe a few sociopaths and psychotics. Bipolar too. Or maybe it's just the bathsalts!

[Tom Brown]

... BTW, a couple of years ago, Scott did seem to be in an "exogenous camp" in opposition to Tobin here:

"Nick, I don't see where you and Glasner disagree. The supply of base money is exogenous and the supply of bank money (i.e. deposits) is endogenous. Don't you both agree with that?

We all agree Tobin was wrong about base money."

http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/09/all-money-is-helicopter-money.html?cid=6a00d83451688169e2015435ac805e970c#comment-6a00d83451688169e2015435ac805e970c

But Nick soon sets him straight (IMO) here:

"Whether one or the other is "endogenous" is a separate question. How much money central and commercial banks *choose* to create may depend on many things, which makes it endogenous if there's a feedback loop from the amount they create to the amount they choose to create."

Yes! "feedback loop" ... my favorite argument! Lol

http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/09/all-money-is-helicopter-money.html?cid=6a00d83451688169e2014e8bcf30cd970d#comment-6a00d83451688169e2014e8bcf30cd970d

:^)