Money. Doing it Right this Time.

The sampling problem is a general problem when measuring time derivatives. The intervals are just much longer in economics.

But if I understand it correctly, Q is a time derivative, and thus not the total quantity of goods. Maybe the flow of goods would be a better term.

You're right. Q is a flow, "goods produced per year".

Integral said:

You're right. Q is a flow, "goods produced per year".

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Goods produced or good sold?

Both, on a technicality.

Q measures "transactions", which you'd expect to equal "sales". Now the difference between sales and production, intuitively, is inventory accumulation. When measuring GDP, we count inventory accumulation as "sales of a company back to itself."

That way, sales = production in the aggregate.

How is wastage accounted for?

Cutlass said:

How is wastage accounted for?

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I don't think you need to account for it in this context. Once goods are wasted or consumed, they stop being sold. So on first approximation they do not enter the equation for monetary policy any more.

I meant in the context of the margin between production and sale. I don't know what the number is. In the US it has to be in the $billions every year. But I don't that it's high enough to skew the equation.

Cutlass said:

I meant in the context of the margin between production and sale. I don't know what the number is. In the US it has to be in the $billions every year. But I don't that it's high enough to skew the equation.

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Well, the producing company paid for having it produced. So you could view it as having been sold to the company itself at production price. For monetary policy it shouldn't make a difference whether the products ends up being wasted or ending up in some inventory, as long as it isn't sold to anybody else.

uppi's basically got it. I don't know the exact accounting conventions here though.

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I'd like to ramble out loud about QE for a second.

What is "Quantitative Easing"?

Let's start with an easier question: what is "normal monetary policy"? Normal policy is open-market operations: the Federal Reserve buys and sells short-term Treasury bills.

Now all the Fed's doing is buying and selling a particular asset (short-term Treasuries) to affect a certain interest rate (the interest rate on short-term Treasuries). But T-bills are just an asset. There are lots of other assets out there: long-term Treasuries, stocks, mortgage-backed securities, etc. QE is simply central bank purchases of these other assets, and for the same reason: to push down yields or, equivalently, to push up the price of these assets.

So why is QE considered "unconventional"?

Because "convention" is defined as "OMOs of short-term Treasuries." In addition, OMOs of other assets has the side effect of "picking winners and losers" if the Fed chooses selectively which assets to prop up. At its core, though, QE is simply monetary policy by other means.

Did QE "work"?

Yes and no.

Yes. The rumors of QE2 arrested a fall in inflation expectations and propped those expectations back up, but not enough to their long-run average of 2%.

No. Monetary expansion can only work if it is expected to be "permanent"; temporary injections do nothing. QE2 was expressly designed to be temporary, too small and end too soon. While that sounds like Krugmanite "it's always too small", I have three indicators by which I'd judge QE to be "the right size":
1) push TIPS spreads (=inflation expectations) up to 2-2.5%
2) push NGDP back to trend, which is well-defined
3) push asset prices back up, which is a bit less well-defined

We had QE and we're still in the hole. But QE was poorly framed. Had Bernanke said that "we will do QE until inflation expectations and NGDP are back on track, and we won't stop until they are," you bet QE would have "worked" to bring down unemployment and reducer real debt levels. It also would have spurred real growth and some modest inflation, though the split between the two is dependent on some unobservables so I won't presume to know it.

The point: announcing a fixed number for QE will virtually always fail. Announcing unlimited QE until the economy is back on track might have worked just fine. Buy up every asset on planet Earth, or threaten to do so.

What are the constraints on the freedom of action, though? Bounded rationality is one, of course. But while the Fed is technically independent in the short run, it can't entirely ignore politics over time. And there's always the internal divisions. The Fed chairman doesn't act alone, but has to convince the others to act with him.

You know, just two years ago I'd have dismissed those observations out of hand, but I have been turned around.

Internal Fed politics is real and influences interest-rate decisions. Shocker, I know, but before the recent crisis I hadn't looked at the Fed that way. Bernanke likes to run the Fed on consensus; he won't tolerate more than one or two dissenting votes on a decision. Because of that the "median voter" on the Fed board is actually the second- or third-most-inflation-hawkish person on the Board.

That is bad news in a major recession.

I know the Fed chairman is never on the losing side of a policy vote. And that means that if the wrong people make up the rest of the committee, they can push him around. But by the same token he can push back somewhat. It comes down to the internal group dynamics.

Integral said:

No. Monetary expansion can only work if it is expected to be "permanent"; temporary injections do nothing.

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By "temporary injection" do you mean an injection that is reined in again at a later point, or just a rate of change that is not maintained past a certain point?

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Do I understand correctly that much of the lending spurred on by QE2 occurred via the shadow banking system rather than the regular banking system? What are the implications of this dynamic?

By temporary, never tell them where the end is.

Monsterzuma said:

By "temporary injection" do you mean an injection that is reined in again at a later point, or just a rate of change that is not maintained past a certain point?

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The former. I'm talking about levels, yes, not rates of change. And "permanent" is a bit shaky (there's no such thing as a "permanent doubling of the money supply" just like there are no "permanent tax cuts"), but ideally you wouldn't be saying "we're gonna buy $1T of long-term Treasury debt, then sell it all back the second the economy hints of recovering." That's expressly temporary.

Basically, the effects of "double the money supply at time t0 and remove that injection at stated time t1" are very different from "double the money supply at time t0 and keep that level of base money forever."

Do I understand correctly that much of the lending spurred on by QE2 occurred via the shadow banking system rather than the regular banking system? What are the implications of this dynamic?

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Interesting. The transmission mechanism side is not my area of expertise so I'll defer comment until I've looked into it some more. Thanks.

Thank you for that bit of clarification. I'm curious about one other thing: when a central bank buys an asset at a certain price and later fails to sell it at that same price or higher, what happens to the money that represents the difference between these two prices? Does this money cause a lingering inflationary influence in the economy? Is there some mechanism for getting rid of such inflationary traces or are they just ignored?

Also, is it true that under certain conditions it is possible for a central bank to go insolvent? How exactly would this happen and how is it dealt with?

The central bank's activities are an ongoing process. If you don't get exactly the result you are looking for with one transaction, you just have another one to make up the difference.

I don't see any way for a central bank to go insolvent. They print the money, after all.

That said, with a gold standard it would be possible. If the bank couldn't afford to buy any gold, then they would be in real trouble. Or a country today that pegged their currency to a stronger one, like the dollar, can run into trouble if they run out of dollars.

Monsterzuma said:

Thank you for that bit of clarification. I'm curious about one other thing: when a central bank buys an asset at a certain price and later fails to sell it at that same price or higher, what happens to the money that represents the difference between these two prices? Does this money cause a lingering inflationary influence in the economy? Is there some mechanism for getting rid of such inflationary traces or are they just ignored?

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In a word, yes, though it depends on how the central bank initially bought the asset.

If the bank "prints up money" and uses freshly-printed money to buy an asset, then sells the asset at a loss, then the money supply has expanded on net; there will be inflationary pressures.

If the central bank does not increase the money supply initially (perhaps by first selling one of its assets and using the proceeds to buy a new asset), then the difference becomes a capital loss for the central bank, just like for any other "normal" bank. Since there was no initial expansion of the money supply, there would be no inflationary pressures.

Typically the quantities involved here are small enough to be ignored but it does happen. It also happens in the reverse direction: the central bank can make profit on the assets it buys. It then remits those profits to Treasury and they become part of what finances government spending.

Also, is it true that under certain conditions it is possible for a central bank to go insolvent? How exactly would this happen and how is it dealt with?

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It's possible but rare. The main way I can think of this happening is if a central bank engages in currency mismatch, accumulating assets denominated in a currency other than the one it issues.

Endgame typically involves the IMF getting involved and burning the economy of said country into the ground organizing a rescue package.

I'm skeptical that money is simply a neutral way of keeping track of things. Money always seems to have a way of rising to the top.

From what I've read alot of the current wealth-distribution issues started really exacerbating when central authorities starting banning local currencies during the Renaissance. In Life Inc Douglas Ruskoff talks about this.

It seems like those in power tweak & alter the rules of money while the poorest just try to scheme ways to get enough to stay alive. Personally, I always enjoy ways to avoid using it as much as possible, barter, reusing & recycling the products I already have, etc. I can see why money is necessary but it pisses me off how dominated it is. Like if two gamblers meet somewhere to gamble, no matter who wins those at the top win. Because 90% of that money is going straight up, to the global food megaliths, gasoline companies, Chinese factory owners, etc. Some might go back to their communities but most of it probably does not.

The notion that money (or even barter) has been quite as ubiquitous among human societies as is commonly assumed is one not unchallenged among historians. In his book "debt: the first 5000 years" anthropologist David Graeber presents a persuasive case that credit appeared both sooner and more commonly than money in human culture:

Before there was money, there was debt

Every economics textbook says the same thing: Money was invented to replace onerous and complicated barter systems—to relieve ancient people from having to haul their goods to market. The problem with this version of history? There’s not a shred of evidence to support it.

Here anthropologist David Graeber presents a stunning reversal of conventional wisdom. He shows that for more than 5,000 years, since the beginnings of the first agrarian empires, humans have used elaborate credit systems to buy and sell goods—that is, long before the invention of coins or cash. It is in this era, Graeber argues, that we also first encounter a society divided into debtors and creditors.

Graeber shows that arguments about debt and debt forgiveness have been at the center of political debates from Italy to China, as well as sparking innumerable insurrections. He also brilliantly demonstrates that the language of the ancient works of law and religion (words like “guilt,” “sin,” and “redemption”) derive in large part from ancient debates about debt, and shape even our most basic ideas of right and wrong. We are still fighting these battles today without knowing it.

Debt: The First 5,000 Years is a fascinating chronicle of this little known history—as well as how it has defined human history, and what it means for the credit crisis of the present day and the future of our economy.

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http://www.amazon.com/Debt-First-5-000-Years/dp/1933633867

I haven't read it myself yet but have asked to be given it as a present in a few days.

Narz said:

I'm skeptical that money is simply a neutral way of keeping track of things. Money always seems to have a way of rising to the top.

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I believe one of Graeber's central theses is that the use of money emerges primarily between individuals and groups that are not on a friendly basis with each other. Under other circumstances either a "gift economy" (i.e. good traded for informal "brownie points" that individuals trust will be respected later) or a credit economy where a third party is trusted to record balances between trading partners appears more commonly. So your suspicion in this regard may be justified.