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Money. Doing it Right this Time.

Discussion in 'Off-Topic' started by Cutlass, Nov 25, 2011.

  1. Quackers

    Quackers The Frog

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    Well I understand the proccess and when I first came accross it, it was a bit of a shock that private firms were just *allowed* to create money.
     
  2. innonimatu

    innonimatu Deity

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    Well, looks like you haven't yet understood how banks operate!

    If banks were no different from any other entity then you could, for example, offer a $1000 loan to your neighbor without you actually having any money to start with. You would just write up "this is worth $1000" in a scrap of paper and give it to him (your new liability), and he would write "I owe you $1000 plus x$ interest" and hand it to you (your new asset). And (this is the important part) banks would unconditionally accept your written scrap of paper at face value, and the central bank would accept your neighbors promise to repay at (nearly) face value if you anted to exchange it for state-issued money (though I'm sure that Cutlass will keep disagreeing with the "at will" part).

    But you can't get away with doing that. You'd have to set up a bank to do it. It's understandable, other banks would have a need to verify that their counterpart deserves any trust.But it's also true that this means banks have a special privilege of charging interest on money they create at will.
     
  3. Monsterzuma

    Monsterzuma the sly one

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    Actually, you can do it. The problem is, people will laugh at you. They will not take your "deposit account" as a store of value because it isn't one. This is why I'm interested in the issue of taxation. Banks CAN do this because the government accepts a drain from their deposit accounts as a tax payment. And that's what makes them different.

    Of course, if you have a gang or army to enforce repayment from people when they exceed a certain debt limit, you've got a well oiled business on your hands. But that won't fly when there already is a monopoly on the use of force.

    edit: sorry, didn't read you carefully enough. on second glance your description captures it pretty well already.
     
  4. Cutlass

    Cutlass The Man Who Wasn't There.

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    Actually, in the Free Banking Era, people did do it as inno described. And it worked. The reasons for it working included information costs, it was too costly to figure out how sound a bank was, and a basic desperation for money because government money was simply too tight for the needs of the public. Better a money you knew that you couldn't rely on then no money at all.

    However a lot of people got defrauded out of a lot of wealth that way. And eventually the government decided to set up certain standards to prevent the worst of the abuses. So anarcho-capitalism has been done in banking. And "market money" has been the money supply. And the results were not at all what the Austrian Economics people claim it would be.

    So now we have rules that protect the depositor and the money supply. And because of that we've had a far more stable era in finance. The instability in finance resulted from a combination of factors that threw the old rules out the window and resulted in something much closer to "free banking" than anything seen in the US since before the Great Depression.

    It's not banking that caused the financial crisis, it's banking without rules that caused the financial crisis.
     
  5. Monsterzuma

    Monsterzuma the sly one

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    I think I've found the answer to my own question ("how does taxation work in this context"):

    As Neil Wilson told me, reserves are needed to settle net inter-bank payments. This also includes payment from clients of a bank to clients of the Federal Reserve. Since any tax payments pay off debts of the government to the Federal Reserve (i.e. diminishes the debt liability of the government at the Fed), a tax payment involves a transfer of reserves from the commercial bank in question to the Fed. I assume this just means the commercial bank's deposit account at the Fed is drained.

    So the gap between deposit accounts and reserves is closed for the bank clients when taxes are paid.
     
  6. wolfigor

    wolfigor Emperor

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    In other words money is not very different from somebody writing an IOU.
    A bank is this "somebody" having large deposits, strong reputation, and a legal duty to repay all the IOU (at least to some extent).

    In theory any organization (imagine a company like Apple with large deposits of money and reputation) could create its own money that could become widely accepted mainstream.

    I remember the "experiment" of second life and its linden dollars that was going in that direction... even if the Linden Dollar never came out of virtual transactions.





    Even more troublesome for me is this example of fiat money becoming "real" thanks to the banks intervention.
    Central bank (pretty much the state itself) lent cheap money to banks and they used such money to buy government sovereign bonds.
    http://www.nytimes.com/2012/04/09/b...nce-more-buying-bonds-seen-as-vulnerable.html
     
  7. Monsterzuma

    Monsterzuma the sly one

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    I was curious if we could discuss the views of Scott Sumner and Market Monetarists in general.

    I get the impression that NGDP targeting roughly comes down to using inflation engineering as a form of demand-side stimulus in order to get the economy back to full output (i.e. low unemployment, low capacity under-utilization, no GDP output gap). This is explicitly not done in an ad-hoc way tailored to the situation, but as a systematic policy that kicks in whenever it is needed. I.e. when too negative a shock to GDP occurs, inflation temporarily exceeds its ordinary range so that NGDP growth is kept stable. I imagine this could also happen the other way around (too high NGDP growth = lower inflation?). Any past errors in this regard are also corrected for by the fact that the NGDP level, rather than growth rate, is what is targeted.

    What I'm curious about is how the central bank can guarantee that the inflation stimulates demand rather than diminishing supply (for example, by causing commodity prices to be bid up). Can't the money that is created basically cross borders freely and bid up markets other than the domestic production/consumption based one? I imagine that in as far as there are no protectionist barriers this would make no difference, since any money that would "want" to flow out would already have done so, but is this how it is in reality? I imagine QE puts comparatively more money in the hands of banks/investors and less in the hands of wage earners, which should involve some differences in terms of tendencies and abilities to put the money in one place rather than another. Does this cause any distortions?

    How does the empirical effect of QE1 and 2 measure up to the Market Monetarists' thesis? Is the "jobless recovery" consistent with the notion that QE generates demand? Or would Market Monetarists argue that there has simply not been enough of it?

    Also, what is the significance of the buildup of excess reserves at banks in this context? Is there even any indication that QE is "working" given this fact? How plausible is the idea that the stock markets are bid up based on a "placebo effect" from the expectation that these reserves will be lent out when in reality they never will?

    I am of course also interested in discussing how Market Monetarism combines with endogenous money theory. If endogenous money theory is right, what would the effect of NGDP level targeting be?
     
  8. Cutlass

    Cutlass The Man Who Wasn't There.

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    I haven't really been following the Market Monetarist debate, so I don't know that I can answer your questions with much depth. That said, at the core of monetarist concepts, Integral and I have much different perspectives. In that, at heart, I think that money does not play the role in the economy that monetarists do.

    The traditional analogy about the government policies is that it is like a car with 2 gas pedals and 2 brake pedals. Monetary and fiscal policy. Either can cause acceleration or slowing. But sometimes the 2 are used in conflict because independent central banks have different priorities than governments. So, for example, in the early years of his presidency Reagan had a very expansionary fiscal policy. But the Fed under Volker had not ended the inflation of the 70s yet, and so there was an extremely restrictive monetary policy until the inflation was brought under control.

    Me, I disagree with that analogy/model. In my mind the car has 1 gas pedal and 2 brakes, but the road is an long incline where the natural tendency is for the car to go faster and faster until it loses control and crashes, like those video game race care driving games. After the crash there is a period of getting back on the road and then accelerating again to make up the lost time. In this analogy fiscal policy is a gas pedal or a brake pedal, but monetary policy is only a brake pedal.

    Spoiler :
    (You probably have little idea how far outside the mainstream I'm getting here, but I do, and it's my theory, and I'm sticking to it!)


    In this theory, money has no power as an economic accelerator. Money is either free enough so that it is no impediment to the acceleration of the car however fast it wants to go for whatever steepness the road is at that point, or it is riding the brake and holding the economy car back so that it doesn't go out of control and crash.

    The old expression "pushing on a string" is generally consistent with my views here.

    Why do I feel this way? Because money has no forcing power towards acceleration. It only has forcing power towards retardation. (As an aside, this is also why I believe that tax breaks are an absolute crap economic stimulus. Same song, different verse.) If I, the government, put an additional $10 in your pocket, I cannot in any way compel you to spend it. So the stimulative effect is extremely weak at best. However if I go and spend it myself, then the stimulus is much stronger. And if I invest it in a real productive asset, stronger still. No amount of additional money in the hands of consumers or businesses compels that money to be spent.

    And that is where I break with both monetarists and supply siders.

    So what do I think about the Market Monetarists approach (to the small extent that I have looked at is)? Highly skeptical. Doing a brief review of their basic tenets on Wiki, the thing that initially stand out is that their system believes in, and in fact seems to rely on "Rational Expectations". And that immediately makes me believe that they must be wrong. For in the real world, expectations are not rational. Integral talked about it a bit earlier in the thread. The second part where I think the monetarist approach in general is wrong is that in targeting nominal growth of, really any variable, there is no way in policy to differentiate growth from inflation. So the old Monetarists would target 4% growth, but they might get 4% growth and 0% inflation, or they might get 0% growth and 4% inflation, or any combination of the two. The policy was blind to which one you got. It was simply an assumption that it would be growth instead of inflation. The old Monetarists also lost it in that they advocated money growth rules. And those failed because they were targeting the monetary aggregates and ignoring the other variables, like Velocity. And so their theories failed in the real world. The Market Monetarists corrected the failure to understand Velocity, but retained the focus on rules that tie up the discretion of the central bank. And I don't think you can do that without the rules becoming the source of the problem that they were created to prevent. I think you fundamentally oversimplify when you say that any one policy rule is going to work in all times and places.

    Now as to the "crossing borders" that you mentioned, as I have talked about in my previous posts, I think that money flows across borders like water does. With about as little restriction. And so any economic policy that does not take that into consideration is going to be wrong. And speculation is also a Big issue that I don't think Monetarism or Market Monetarism deals with at all well. Remember the earlier discussion that money does not sit idle. It is always looking for a rate of return. When it cannot be profitably invested, or it is not wanted for consumption, it has to hunt for other uses. And those uses are like a bored teenager with money in his pocket: He'll probably be up to no good.

    And so, bubbles. And bubbles. And bubbles.

    I don't think you're going to see a lot of stimulation of real consumer demand without an increase in supply. Say's Law is bunk. But the inverse of Say's Law holds pretty well: Demand does create it's own supply. When there's a lot of money chasing a product, someone will produce more of the product. But when there's a lot of money chasing a more or less fixed quantity of a commodity, then all that money is just going to bid up its price. So we have housing bubble, and stock bubbles, and oil bubbles and art bubbles and comic book bubbles and collectibles bubbles and on and on.

    I'm also concerned that the Market Monetarists policy prescriptions would tie the CB's hands in other ways. We discussed earlier the idea that banks could force the hand of the CB rather than the other way around. Now, that doesn't happen. Under Market Monetarism it might. Central Bank policy must be discretionary, at least to a substantial degree. Some targets, Integral makes the case, can be useful signaling that can enhance stability. But once you remove discretion, you cause instability instead of reducing it. In this the Market Monetarists seem to be making the same fundamental failure as Friedman's Monetarists and the Austrian School: That is, first and foremost, you have to begin with the assumptions that the economy is inherently unstable and that people will do monumentally irrational things within it. It is not the government, and not the central bank, which is the cause of the instability. The instability is a natural part of the system.

    The rules based approach to central banking assumes an inherent stability of the system rather than an inherent instability. And as such is doomed to failure.

    Without more thought into it I'm not sure how much further I could answer the theoretical parts of your question.
     
  9. Integral

    Integral Can't you hear it?

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    Disclaimer: Scott Sumner is a friend of mine and I've been convinced by many of his core claims. I've written for the Market Monetarist blogs from time to time. So realize that I have a stake here, and I'm going to be making arguments for a particular position.


    So the first thing to get out of your head is the idea that "the central bank causes inflation alone" (that's only true in the long run), and the idea that all negative shocks to GDP are created equal. They are not: shocks to GDP comes from underlying supply or demand shocks. The central bank can mitigate demand shocks and make people better off; there's little way for the central bank to mitigate supply shocks without just making things worse.

    The central bank steers aggregate demand, which shows up as a mixture of inflation and output. Specifically, in macroeconomics there are two curves:

    MV = PY (AD)
    P = f(E(P), P(-1),Y) (AS)

    The central bank sets M and the expected future path of M. By setting the expected future path of M, they set the expected future path of PY. How that path of PY splits into inflation/output is determined by the "other" curve, by the aggregate supply curve. If there's a shock to V, say a financial crisis or whatever, AD falls. This reduces PQ. The central bank promises to restore PQ to its previous level.

    This is a model of the economy. It has a few key components.
    1. Claim: The central bank can determine the path of PY.
    (Status: pretty well true. The central bank can control P, if you believe normal inflation-targeting theory. Therefore the central bank can control PY)

    2. Claim: Current aggregate demand depends critically on expected future aggregate demand. That means that credible central bank promises to raise the path of AD (by monetary injection/QE/whatever) have effects today. There are a variety of mechanisms by which this might work.

    3. Claim: Aggregate demand affects both prices and output, because prices and/or wages are sticky in the short run. (Status: if this isn't true, then all central banking is worthless. You have to have a non-vertical AS curve.)

    3. Claim: Level targeting works better than rate targeting. The level of employment is determined by the level of aggregate demand. If the central bank is going to target growth rates, it risks an AD gap which yields elevated unemployment. If the central bank closes the AD gap, it will bring down unemployment, and only then. Caveat: over the long run supply-side effects kick in and can bring unemployment down, adjusting to a new nominal growth path. (Status: this is an empirical claim, and seems to be working pretty well. The Fed has restored growth rates but not levels, and unemployment has stalled but not dropped, aside from the aberrations of the most recent few months (the long run kicking in?)).

    "Can't the money cross borders?" Standard MM theory is all for a closed economy. The optimal central bank policy changes somewhat in an open-economy context and there aren't many MM researchers doing open-economy stuff. Lars Christensen is leading the way, but I don't have a good rejoinder for that off the top of my head. Ask me again in a few posts. :)

    "QE questions" So in theory, the method of monetary injection doesn't matter. In practice it might. Yes, in general QE puts cash in the hands of creditors instead of debtors, but in the end (if the injection is expected to be permanent) you still have the hot-potato effect, and AD still rises.

    "Is QE successful?" QE is successful if it yields higher expected future aggregate demand. We can measure expected future inflation through TIPS spreads, and we handwave and say that expected future inflation is proportional to expected future NGDP growth. Empirically, QE has raised TIPS spreads and hence has been expansionary. What we really need is a futures market for expected NGDP growth...
     
  10. Tristan_C

    Tristan_C Emperor

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    Home bias more deserves more weight of consideration than this. The US has a total stock market capitalization of about $16 trillion, which as a portion of the planet's $51 trillion, implies that US investors would expectedly have 68% of their assets in foreign equity assuming "money flows across borders like water does." Instead we invest 73% domestic and 27% foreign. The observed home bias is about 80% (check pp.20-25), a fairly average level observed throughout Europe as well. One rather nice thing for the dollar is that the US was, and remains, the #1 shop for foreign investors who have overcome the home bias.

    Government expenditures generate raw velocity as you say, but not any higher derivative. The US government's track record in generating acceleration out of transfer payments, in investing in things that will actually grow of their own accord, is dismal. Buying booze for the homeless, just for instance, is unambiguously inferior to letting a miserly aristocrat hoard the money in a bank. The line of production generated by the booze— agriculture, brewing, shipping— terminates with consumption of the good, where it basically turns into piss and negligible production. The homeless guy gets to live another day to demand more booze, but if he generated no production after drinking— that is, if goods lose all of their momentum at the point of consumption— then this was not even an investment... just a dead loss.

    Whereas a bank lends out up to 90% of its deposit inventory. Car, house, and business loans go to people that are expected to generate some kind of production sufficient to pay off the loan. Thus the miserly aristocrat's money generated second derivative vectors out of the money supply, which aren't widely observed from stimulus spending or transfer payments.
     
  11. Cutlass

    Cutlass The Man Who Wasn't There.

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    I wonder if part of that home bias is a safety bias issue? After all the financial crises in the LDCs, there's reason to think that there would be a safety premium. Just as foreign money comes to the US for safety, US money probably stays home for safety.


    Government spending matters in how it is spent for the determining the return it generates. Deficit spending given to the rich generates essentially no increase in economic activity. It's a pure loss for the taxpayer. There's trivial consumption increase, and to all intents and purposes not a penny of it will ever be invested. Where as if the government invested the money directly the return to that investment will probably be much higher than the costs of it. So for every dollar spent we see about $1.60 in economic activity for government investment, or $0.20 for tax cuts for mainly the rich. So overwhemingly the best option is direct government investment, and then benefits to the poor and the middle. It cannot be justified providing any money to the "aristocrat", because that is a dead loss and the taxpayer will end up, after interest, paying more than $1 for every $1 in deficit that goes to the rich.
     
  12. Cutlass

    Cutlass The Man Who Wasn't There.

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    This part actually kind of freaks me out. $4.45 trillion of US federal debt is held by foreigners in a $15 trillion economy. That is no small change. And there's a lot of non-governmental money flowing in to the US as well. If people are not assuming from a start an open economy, then that really makes me think something is missing the boat in a big way.
     
  13. Tristan_C

    Tristan_C Emperor

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    One thing about home bias, which I'm unafraid to mention on April 16th, is the tax nightmare. Small-timers would prefer to invest at home and declare the results to a single entity on familiar forms.


    That would be the Scrooge McDuck theory of wealth, whereby the rich store all their assets in hard coin completely out of circulation.



    But in reality, that is not how people become rich, nor is it how cash is stored. Bank deposits are made into loans to people who put the money to use in order to pay back with interest. Furthermore, stocks and securities are themselves just paper, held by the buyer; the actual cash goes into circulation just like the bank deposits. The government draws upon the same pool of prospective investments that private citizens do: companies, employees, contractors. But unlike private citizens, governments are not particularly interested in actually growing an investment and drawing returns, and this lack of incentives shows in their programs' lack of lasting benefits.
     
  14. Cutlass

    Cutlass The Man Who Wasn't There.

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    That's the theory. The reality doesn't actually work out that way. When there are no consumers in sight, people do not invest. Which is why the recovery is lagging. But you also have the examples of the Reagan administration, which had no new net business investment over the course of 8 years, despite massive increases in the wealth available at the top. And the Bush administration, which had essentially no private sector job creation over 8 years, even if you discount the jobs lost to the financial crisis at the end. Virtually every job created during the Bush years was created either directly or indirectly by government. And that was not just a massive increase in wealth at the top, but was also under conditions of heavy deregulation and very weak labor. All things that are claimed to result in business investment, and all things that did not do so in practice.

    So the supply side theory has a 100% failure rate over 30 years in the US. There's no sense in giving it any credit now.
     
  15. Tristan_C

    Tristan_C Emperor

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    It's not theory— it's just the mechanics of banks and securities. "People do not invest" is a non-sequitor concern because if people turn away from securities, they deposit in banks instead. And banks invest their inventory under almost all circumstances.

    I say almost, because it looks like your Scrooge McDuck model is finally coming into practice... on Obama's watch. Completely without precedent.

     
  16. Cutlass

    Cutlass The Man Who Wasn't There.

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    It's not without precedent at all. At other times the money not being invested goes to make bubbles. That's the reason that we had so many of them recently.

    However, the one thing you have not addressed is the fact that investment has not taken place in concert with their being more money in the hands of the wealthy. You are still dealing with a theory that has 0 evidence.
     
  17. Hygro

    Hygro soundcloud.com/hygro/

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    Buying stock of a mature company is not exactly "investing" in the growth of the company, but transferring ownership from one person to another. Similarly, giving your money to investment and trading operations like hedge funds often results in taking advantage of a nearly zero-sum capital gains strategies like currency speculation, commodity arbitrage, etc, the only benefit of which is "liquidity".

    When the rich get big breaks, they don't go out and fund expansions to their businesses or create new enterprises. They park their money in dividend stocks or in hedge funds. Some of that results in new growth, i.e. we see that, say, 20cents returned for a dollar in breaks (somewhere I should have the lecture slide that has the exact amount... I think it might be closer to like 30 or 40 cents), but most of it just circulates around shifting wealth up the pyramid.


    As Cutlass said, the best stimulus is not tax breaks for the wealthy. That's not even real supply side economics, which was the winning economic strategy for postwar Germany and Japan (only because they had the rich-ol' USA to export to). It's just cronyism. The best stimulus is giving cash starting to the poorest first and working back up.

    Infrastructure spending is a big improvement from cash to the top, though not as good as cash to the bottom. I forget if it breaks even dollar for dollar. Though with our aged infrastructure it might stave off horrible costs of infrastructure collapse, making it worthwhile.
     
  18. Monsterzuma

    Monsterzuma the sly one

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    I'm agnostic on whether tax breaks for the wealthy stimulate an economy well, but it seems rather pointless to do it when the federal funds rate is hugging zero, considering any additional savings aren't going to bring it any further down.
     
  19. Hygro

    Hygro soundcloud.com/hygro/

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    Let me scan my reading, I might have the chart that will tell you the historical/statistical breakdown of different fiscal stimulus.
     
  20. Integral

    Integral Can't you hear it?

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    No one, to my knowledge, has satisfactorily analyzed the relative marginal effectiveness of "different kinds" of "fiscal stimulus."

    It's hard enough trying to come up with a summary statistic for the marginal G multiplier, much less break it down into components.
     

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