Money. Doing it Right this Time.

[Monsterzuma]

I think I've heard Scott Sumner claim a number of times that under CPI inflation targeting, demand side fiscal stimulus is ineffective. Is this because he thinks increased deficit spending always creates an inflationary effect on the currency that is spent in, which would be offset by monetary tightening? I could see that being the case if all the spending happens on consumer items, considering there would be the same number of goods but a larger number of claims on them, meaning prices in the aggregate would have to rise. But it's less obvious to me when the spending happens on investment assets and infrastructure like it usually does when the government spends (after all the govt needs a return on the investment to repay the loans).

Is the only thing Krugman and Sumner disagree with on this issue that the former thinks monetary stimulus is ineffective at a 0% FFR whereas the latter doesn't? (i.e. Krugman thinks deficit spending is needed to keep inflation high? seems hard to defend considering inflation is at the fed's target right now)

 

[Integral]

The short answer is yes.

Start in a state where the Fed is getting what it wants: 2% inflation. Suppose the government starts buying more goods. This will generally raise aggregate demand, causing upward pressure on income and prices.

The Fed reacts to rising prices by adjusting monetary policy to keep inflation stable. This depresses aggregate demand until we are at the same situation as we were in before the government's expansionary policy. The composition of output will change but its aggregate level will not

(If we start in a situation where the Fed is not getting what it wants, i.e. sub-2% inflation, then the Fed will accommodate fiscal stimulus until inflation hits 2%, then offset fiscal stimulus afterwards through monetary contraction.)

And yes, the main disagreement between Sumner and Krugman is the relative effectiveness of fiscal and monetary policy at the zero lower bound on 3-month nominal interest rates.

 

[innonimatu]

I could see that being the case if all the spending happens on consumer items, considering there would be the same number of goods but a larger number of claims on them, meaning prices in the aggregate would have to rise.

Assuming the same number of goods doesn't make sense. The consumer goods industries have plenty of capacity to spate to increase output very quickly.

Assumption, assumptions, and more assumption. Unrealistic assumptions. All these models used to justify how modern country's economies are being run are built on thin air!

 

[Monsterzuma]

Assuming the same number of goods doesn't make sense. The consumer goods industries have plenty of capacity to spate to increase output very quickly.

that is a good point, although it would alleviate the deflationary effect of the capacity under-utilization... That effect is probably a rather sluggish thing, though, since otherwise the under-utilization would be gotten rid of immediately. So I could see an argument that it speeds up the process...

Start in a state where the Fed is getting what it wants: 2% inflation. Suppose the government starts buying more goods. This will generally raise aggregate demand, causing upward pressure on income and prices.

Does this also hold when the spending happens on investment assets (which are not included in the CPI)? I imagine there would be secondary effects via which the spending would propagate into the consumer market, but are these as strong as the whole injection or less so? In other words, is there any money that sort of "lingers" in the asset market where it doesn't affect the CPI, keeping asset prices relatively bid up?

And yes, the main disagreement between Sumner and Krugman is the relative effectiveness of fiscal and monetary policy at the zero lower bound on 3-month nominal interest rates.

That's what I thought, although it's always confused me a little that Krugman is so critical of austerity measures in Europe, where the equivalent of the FFR is not at 0% yet. I'm guessing his opposition to these runs deeper on some fronts.

 

[Integral]

Does this also hold when the spending happens on investment assets (which are not included in the CPI)? I imagine there would be secondary effects via which the spending would propagate into the consumer market, but are these as strong as the whole injection or less so? In other words, is there any money that sort of "lingers" in the asset market where it doesn't affect the CPI, keeping asset prices relatively bid up?

Strictly speaking, the mechanism only works for consumer price inflation. The Fed's stated target is 2% inflation in the headline Personal Consumption Expenditures price index (an exceedingly poor target, but whatever). In practice I think the Fed looks at a variety of inflation indicators when making decisions about policy.

 

[Hygro]

I misplaced my notes: why do central banks end up raising interest rates in response to tax hikes--an action that has to do with a bug in their economy-managing script? It was something really stupid and obvious.

 

[Cutlass]

I misplaced my notes: why do central banks end up raising interest rates in response to tax hikes--an action that has to do with a bug in their economy-managing script? It was something really stupid and obvious.

Do they? I don't think it's that simple. As Integral said, they look at a variety of factors. And tax increases are a fiscal contractionary policy, which would place downward pressure on inflation, and so would not trigger higher interest rates. In a closed economy model higher deficits would suggest higher interest rates as a counter. In an open economy, that doesn't necessarily work as intended.

 

[Millman]

Maybe this unless it's another means of control.

http://www.ronpaul.com/congress/legislation/111th-congress-200910/audit-the-federal-reserve-hr-1207/

Though if everyone were competant we wouldn't need others to make decisions for us.

 

[Integral]

Hygro: I'd have to look at some data before commenting. It sounds highly unusual.

Millman: I'd love to discuss some of Paul's claims here, but one-liners are not the way to go about it. Nevertheless, I'll tackle a few of Paul's talking points.

(1)The Federal Reserve is the chief culprit behind the economic crisis. (2)Its unchecked power to create endless amounts of money out of thin air brought us the boom and bust cycle and causes one financial bubble after another. (3)Since the Fed’s creation in 1913 the dollar has lost more than 96% of its value, and (4)by recklessly inflating the money supply the Fed continues to distort interest rates and intentionally erodes the value of the dollar.

1. "The Fed is the chief culprit behind the crisis."
True, but not for the reasons Paul states. I have been highly critical of the Fed's actions during the crisis: I think monetary policy ought to have been several degrees looser in the mid-2008 period, though I admit that political and institutional constraints meant that Fed policy was about as loose as it was going to get.


2. "Money creation causes the boom and bust cycle."
Actually, possibly true. Swings in the money supply are a key component of business cycles, and it's the Fed's job to keep the money supply growing at a rate that meets money demand. However, Paul's alternative (a commodity standard) would do no better at meeting money demand.

There are better rules out there: inflation targeting, price level targeting, nominal GDP targeting...


3. "Since the Fed's creation the dollar has lost 96% of its value."
Nobody thinks on a horizon of 100 years, and if they are, they certainly aren't using money as a store of value. If you are really, truly worried about the value of your assets over that kind of time span, invest in something that has a nonzero real rate of return.

I do not dispute the claim; it is factual. I dispute that the claim is relevant to anything.

You're complaining about 3.3% average inflation over the span of 100 years. Think about that for a second.


4. "Reckless inflating of the money supply distorts interest rates"
The Fed does its best to keep the interest rate near the natural rate, that rate being where quantity of savings supplied = quantity of investment demanded. Look, we live in a monetary exchange economy. If we lived in a barter economy, it wouldn't matter what the Fed is doing: they couldn't even influence real interest rates, much less distort them. But we live in a monetary economy, which means whoever is supplying money has some power over the nominal interest rate; with the reality of sticky prices, that means the Fed has some power over real rates. The best we can do is try to ensure that the real rate is close to its natural rate.

As to the first part of the sentence...we could certainly use a little inflation in the money supply right now! Money is far too tight.


5. Commodity standards.
You can peg the dollar to gold if you want. What that would mean in today's terms is that the Fed would monitor the gold market, and buy (sell) gold whenever the value of gold creeped down (up). How is that any more or less interventionist than targeting the price of bonds?


6. Audit the Fed!
Do you even know what that means? I want an honest answer. Tell me what you want to know about the Fed that isn't already public information, and we'll talk.

 

[Monsterzuma]

As to the first part of the sentence...we could certainly use a little inflation in the money supply right now! Money is far too tight.

how did we get to the point where a 0% federal funds rate and 1.4 trillion dollars' worth of excess reserves in the banking system is "too loose policy"? what brought about this situation in your views?

what I'm having trouble getting my head around is that the EU and US have private debt levels around 300% of yearly GDP (+ another 80 to 100% of public debt) and yet interest rates are at historical lows. obviously the depressed economy is an influence, but it isn't satisfactory as an explanation of this "savings glut". the Chinese currency peg via which their government effectively forces it's citizens to save in the US treasury market is important, but how can a +/- 6 trillion dollar economy support the debts of two 14 trillion dollar ones? that by itself is also a drop in the bucket compared to the 50 trillion dollars * 2 of debt out there. doesn't it just look like savings are appearing out of nowhere here?

 

[Cutlass]

how did we get to the point where a 0% federal funds rate and 1.4 trillion dollars' worth of excess reserves in the banking system is "too loose policy"? what brought about this situation in your views?

what I'm having trouble getting my head around is that the EU and US have private debt levels around 300% of yearly GDP (+ another 80 to 100% of public debt) and yet interest rates are at historical lows. obviously the depressed economy is an influence, but it isn't satisfactory as an explanation of this "savings glut". the Chinese currency peg via which their government effectively forces it's citizens to save in the US treasury market is important, but how can a +/- 6 trillion dollar economy support the debts of two 14 trillion dollar ones? that by itself is also a drop in the bucket compared to the 50 trillion dollars * 2 of debt out there. doesn't it just look like savings are appearing out of nowhere here?

Not to me. The US has been running trade deficits for 30 years now. That deficit is loaned back to us. It's not just China. It's most of the semi-developed world. It's OPEC, the Asian Tigers, Japan, most of Latin America, and the US had money fueling the housing boom from banks and pension funds throughout the developed nation as well.

You can say that money fuels the bubble which causes financial crises, and that may well be true. But it does not follow from that that the money is created domestically by the central bank. Not in a world where we can watch the past 2 decades money flowing from country to country and causing havoc everywhere it goes.

Money is too tight because it is not being made available to those borrowers that could make effective use of it. Now what do you do to address that problem? Money is also too tight in that it causes real borrowing costs to be too expensive. Which discourages would be borrowers of money for useful purposes. Both those factors result in excessively slow growth of the economy.

 

[innonimatu]

Not to me. The US has been running trade deficits for 30 years now. That deficit is loaned back to us. It's not just China. It's most of the semi-developed world. It's OPEC, the Asian Tigers, Japan, most of Latin America, and the US had money fueling the housing boom from banks and pension funds throughout the developed nation as well.

You can say that money fuels the bubble which causes financial crises, and that may well be true. But it does not follow from that that the money is created domestically by the central bank. Not in a world where we can watch the past 2 decades money flowing from country to country and causing havoc everywhere it goes.

Money is too tight because it is not being made available to those borrowers that could make effective use of it. Now what do you do to address that problem? Money is also too tight in that it causes real borrowing costs to be too expensive. Which discourages would be borrowers of money for useful purposes. Both those factors result in excessively slow growth of the economy.

You know, your post above just struck me as a perfect illustration of the absurdity of trying to have one concept (money) doing so many different functions. Money is a reward, for those who enjoy collecting it for its own sake, or as a way of keeping tabs. It's a necessity for those who can get just enough of it to survive on. It's a power store; it's a liability; it's a commercial token; an accounting unit; a claim on favors; a physical item; an immaterial representation; finite; infinite; stable; unstable; and so on. Even its single universally recognized property (having value) is also almost universally recognized to be different depending on who holds it!

Can we perhaps suspend the attempts at being "technical" and get a bit more philosophical here for a while? What you describe above (debts, loans, "tightness of money, etc) are fictions dreamt up by someone that most people then by convention agreed to believe on. Money flowing between countries, money created, costs of borrowing, the availability of money and loans... it all depends on people agreeing to believe it! The amounts, the values, the debts and claims, all the complex web of the stuff. And it changes not only among groups of people, but also over time.

It's no wonder that economist are unable to work out what money is, or what to do about it: no one can! It's like trying to pin down a definition of religion or of law, and them also all the rules for its use. It's too contradictory, too adaptable; it changes so much. Money is always a human convention, and only means what people want it to mean in a particular context! Worse, different people in the same context have different interests and what it mean different things! So, I humbly submit that money just can't be done right any time, however much we discuss it here.

At the most I'd venture a "definition" that money is a tool, one among many that make up the human "technologies of power", the strategies we use in social interaction while fighting and cooperating with each other.

 

[Cutlass]

Sure. Money is a tool. But it's also one that there is no replacement for. You can talk all you want about it's imperfections, but you still have no alternatives at all.

 

[innonimatu]

Sure. Money is a tool. But it's also one that there is no replacement for. You can talk all you want about it's imperfections, but you still have no alternatives at all.

I acknowledge that, just as I have no alternatives to law, and do not expect religion to disappear, for example.

What I guess was my point is that too often we talk about money with far too much certainty. There's nothing certain about it, and so all out best guesses about how the economy is going to be in the future are error-prone. And all economic theory inevitably gets outdated, if it ever was realistic. In the short term, sure, we can guess, make it longer than a generation or so and it's all building on quicksand. People's "consensus" changes.

We take money issues far too seriously as if it were an exact science, and in consequence, lost in those abstractions and ideals, not seriously enough as it affects individual persons.

 

[Bootstoots]

I acknowledge that, just as I have no alternatives to law, and do not expect religion to disappear, for example.

What I guess was my point is that too often we talk about money with far too much certainty. There's nothing certain about it, and so all out best guesses about how the economy is going to be in the future are error-prone. And all economic theory inevitably gets outdated, if it ever was realistic. In the short term, sure, we can guess, make it longer than a generation or so and it's all building on quicksand. People's "consensus" changes.

We take money issues far too seriously as if it were an exact science, and in consequence, lost in those abstractions and ideals, not seriously enough as it affects individual persons.

Certainty isn't a luxury that's given to anyone who has to deal with an extremely complex system in real time. I don't think economists claim to deal with an exact science, but they can still make predictions that are vastly better on average than random guesses. Granted they've still got a ways to go, but society would be much worse off without economists.

Even most "exact scientists" use error-prone models to understand their data, and scientific theories are all based on empirical observation and subject to "scientific consensus". I don't see any reason to think that economics is unscientific field - it's just that their system is poorly understood because of its extreme complexity.

It may be a dismal science, but I think it can be called a science.

 

[Monsterzuma]

For the record: the guy in my avatar, Ray Dalio, manager of the world's largest hedgefund and the most successful one of the last year, is an endogenous money theorist like Steve Keen. His writings leave little ambiguity about the fact that he views credit expansion as a demand generating dynamic rather than a demand displacing (i.e. from patient to impatient individual) one.

Is there a better litmus test for the worth of an idea than that there are people making billions off them?

 

[Cutlass]

Making money in business does not equal understanding economics. Those are only tangentially related subjects.

 

[Monsterzuma]

I'm trying to understand "excess reserves". I know that US banks have about 1.4 trillion dollars' worth of them stacked up, but what exactly is being done with this money? Is it entirely passive or is there any speculation being done with it?

The federal reserve is offering an interest payment of 0.25% a year on these, right? Does that imply that the banks can not "use" the reserves for anything in the meantime?

If the reserves are completely passive, does this mean that the effect of QE1 and 2 on the asset markets was almost entirely caused by a change in expectations and no "real" outflow of money from the banks?

 

[Monsterzuma]

Another thing: is it defensible from Market Monetarist theory that inflation alone rather than the combination of World War 2 and inflation could have ended the great depression by bringing back full demand?

 

[Cutlass]

Another thing: is it defensible from Market Monetarist theory that inflation alone rather than the combination of World War 2 and inflation could have ended the great depression by bringing back full demand?

Probably eventually. Depressions end, unless there's some factor keeping them in play. After 1937-38, the Fed was doing a better job on monetary policy, which likely would have led to the economy making a full recovery eventually. However fiscal policy was still far too conservative. Which was a drag on the system.

I'm trying to understand "excess reserves". I know that US banks have about 1.4 trillion dollars' worth of them stacked up, but what exactly is being done with this money? Is it entirely passive or is there any speculation being done with it?

The federal reserve is offering an interest payment of 0.25% a year on these, right? Does that imply that the banks can not "use" the reserves for anything in the meantime?

If the reserves are completely passive, does this mean that the effect of QE1 and 2 on the asset markets was almost entirely caused by a change in expectations and no "real" outflow of money from the banks?

Banks are still reluctant to make many loans, and many borrowers are reluctant to try and get loans. This results in money sitting and doing nothing. It could be loaned out on very short notice, but that would require higher confidence levels on the part of everyone.

Expectations matter when dealing with policy changes. It's the animal spirits. Simply the fact that the markets came to believe that the government would not allow a freefall made the markets a more attractive proposition.