Rant mode on. It made my flesh creep just to type that title.
Some statements are right. Some statements are wrong. Some statements aren't even wrong. Some statements, like the one in my title, aren't even not even wrong; they are just gibberish.
There are three distinct concepts. 1. "Demand" is what the buyers want. 2. "Supply" is what the sellers want. 3. Then there's what actually happens. What actually happens — the actual quantity – usually depends on demand and/or supply, but it's not the same thing conceptually as either demand or supply. Let's try again.
"The actual stock of money is demand-determined".
That's a bit better. It's no longer gibberish. It gets promoted to the "not even wrong" category. Because "demand" is not a number, it's a curve, or a function. The quantity demanded (which is a number) depends on stuff. Let's try again.
"The actual stock of money is determined by the quantity demanded at the rate of interest set by the supplier."
That's a lot better. It gets promoted to the "wrong" category.
It's wrong, but other than that it's a perfectly coherent theory of the world. Draw a picture with the stock of money on the horizontal axis and the rate of interest on the vertical axis. Draw a downward-sloping demand curve. Draw a horizontal supply curve. The actual stock of money is determined by the point where the supply and demand curves intersect. The actual stock of money depends on both supply and demand, but the supply curve is perfectly elastic at a given rate of interest.
There are two things wrong with that theory:
1. The "demand for money" normally means the relationship between the desired average stock of money that people wish to hold and its determinants. And money, as medium of exchange, is very different from other goods. Even if the demand for money were perfectly interest-inelastic (it isn't, but this assumption is just for illustration), it would be possible for the central bank to increase the actual stock of money, and make it exceed the desired stock of money, simply by lowering the rate of interest. By lowering the rate of interest people would want to borrow more money from the central bank. They would borrow that money, not because they want to hold more money (by assumption they don't), but because they want to spend more money. Money's funny like that. When I sell my car for $2,000 that doesn't mean I have decided I would prefer to hold an extra $2,000 money than hold a car. It normally means I have decided I want to hold a different car, or a bicycle, or whatever. I hold that $2,000 in my inventory of money only temporarily until I pass it on to someone else in exchange for a new car. My stock of money is a buffer stock that makes life easier by avoiding the need for perfect synchronisation of ingoings and outgoings.
2. Except for usually very short periods of time, that aren't usually very interesting macroeconomically speaking, the money supply curve is not perfectly elastic at a fixed rate of interest. [Update: and the monetary system would eventually explode or implode if it were perfectly interest elastic for a long enough period of time.]
Take Canada for example. The Bank of Canada has a Fixed Announcement Date every 6 weeks, at which it looks at everything it thinks is relevant and sets a new target for the overnight rate of interest. And it really doesn't like to change that target between FADs unless something big happens. So drawing a perfectly interest-elastic money supply curve is a reasonable approximation to reality for 6 week periods. For any longer period of time, it's totally wrong.
What's right? Well, the Bank of Canada targets 2% CPI inflation. It does whatever it takes to bring inflation back to the 2% target at a "medium-term" horizon, which it defines as about 2 years. The Bank of Canada does not target the rate of interest (except for the 6 weeks between FADs). It targets 2% inflation, and lets the rate of interest (and any other variable) move to whatever it takes to keep inflation at 2%.
At the Bank of Canada's medium term horizon, the supply of money is perfectly interest-inelastic. It's perfectly income-inelastic. It's perfectly almost everything-inelastic, except for one thing. It is perfectly inflation-elastic.
The money supply curve is vertical on the old picture, once we get past 6 weeks. Redraw the picture, delete the rate of interest on the vertical axis, and replace it with the rate of inflation. Draw the money supply curve perfectly elastic at 2% inflation. [Update: just to be clear, the inflation-elasticity of money supply is minus infinity, so it's perfectly negatively elastic.] That's a bit better.
Rant mode off.
Worthwhile Canadian Initiative 
Note – Fullwiler even writes about how CBs can conduct monetary policy while actively changing the monetary base: “the Fed or any other central bank can only control the size of the monetary base directly by creating … conditions that set interest on reserve balances equal to interest on t-bills.” But it’s about price, not quantity! This is in part about the coherence of one’s explanation of CB policy. This I think is the most coherent way to think about it. The discussion of what is optimal CB policy is separate and up for much greater debate.
On the endogenous/exogenous question, may I suggest an analogy? I have a hedge that grows 1 inch higher per week and a gardener who cuts it back every 6 weeks. If I want to understand the behavior of hedges, I care about the 1 inch per week and if I want to understand the behavior of gardeners, I care how much it is cut back every 6 weeks.
Just because my gardener always chooses to cut my hedge back to the same height does not make the understanding of the growth irrelevant. For example, the gardener can trim back the average rate of growth as much as he wants, but he can never make it exceed 6 inches in 6 weeks. It also explains why my neighbor’s hedge sprawls all over the place when he does not have a gardener.
It would be a little unfair to criticize somebody studying hedge growth by saying that in general hedges do not grow taller because the gardener always cuts my hedge back to the same height.
wh10
okay, but by changing the price the supplier changes the quantity, no?
that’s probably succinct to a fault … isn’t the issue at hand here that it’s misleading to think of the supply of money as just “demand determined” because there’s a supplier whose wants have a role in determining “what actually happens” too. So whilst you are correct (I think) to say that the CB has to supply whatever the quantity demanded is at whatever interest rate it has chosen, it’s choice of interest rate is a determinant of what actually happens (the supply of money) … so it’s still important not to overlook supplier whose wants have a role in determining “what actually happens”.
wh10: no vague metaphors. we agree price and quantity cannot cannot be simultaneously determimed. i am relaxing the assumption that the cb targets rates (this is a choice the cb makes tp do). now what happens in mmt?
… and then i am saying, after interest rates float, the cb fixes reserves. interest rates float, the cb does NOT supply reserves elastically. then what, in mmt?
Nick: “One question for Scott; what happens when the 6 weeks are up, and the interest rate becomes an endogenous variable?”
I won’t answer for Scott but I would say: that depends only on what happens to the bank’s target. If inflation (or expectations thereof) have risen, the bank may hike the policy rate or indicate intention to do so. But nobody (except a few academic monetarists and apparently Paul Krugman 🙂 cares what happened to the base. The CB and the commercial banks couldn’t care less, the former because the base has zero predictive value for future inflation (given current inflation, TIPS spreads, etc), and the commercial banks because regulation gives them zero reason to care. So who makes decisions that matter in the economy watches the money supply or cares about it, which is why it’s time to eliminate it from our models.
If we were physicists we would long since have abandoned talking about stuff (quantity of money) that we can neither define or observe, and get on with the things that we can. The NK model does that. Monetarism is mysticism; the alternative is scientific positivism and it’s high time we learn it.
DWB- this isn’t MMT. It’s a much broader Post-Keynesian theory. Did you read Fullwiler’s piece on the Krugman/Keen debate linked here? He answers your question, and I have already given the answer on the first page of this thread, and W Peden has recognized it. It comes down to understanding what this means for the integrity of the payments system.
Here: http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/04/the-supply-of-money-is-demand-determined.html?cid=6a00d83451688169e20163038fbc97970d#comment-6a00d83451688169e20163038fbc97970d – see the passage from Fullwiler in that comment.
Luis Enrique: I don’t believe the official academics used the term “demand determined,” and if they did, they did not mean it in the way Nick Rowe is critiquing in his post. Perhaps commenters were inaccurate or overzealous. The description of Post-Keynesian endogenous money does not say that the CB cannot affect the money stock by changing the interest rate. Fullwiler makes that very clear that this is possible- but it’s fundamentally price not quantity! This is VERY DIFFERENT than saying the CB can change the qty in a discretionary manner (without using IOR as Fullwiler notes).
And no- that’s an inaccurate and misleading econ 101 way of thinking about changing the price. This is a complex matter to understand. Changing the quantity of reserves in a discretionary manner to change the price is the improper way to think about the fundamental underlying causal mechanism. You have to understand that open market operations are fundamentally defensive in nature. And I think Nick’s Chuck Norris analogy, about not ever having to change qty to change the price b/c that threat exists, misses the point about the underlying causal mechansim. I think this is explained in a paper I linked to in this thread, which Nick helped edit! The mainstreamers and CB experts doing the relevant research have recognized for a relatively long time now that it’s fundamentally about changing price not quantity, regardless of the type of CB being considered. I think I have even read Karl Whelan hammer on this point.
Start with the general case and then go to the US to avoid confusion. I’ve received this explanation from another banking expert:
“Think of a system with no RR and where the cb has the ability to perfectly offset changes to the its balance sheet, and where banks are perfectly certain they can end the day without an overdraft or there is no penalty for such an overdraft. This is basically Canada, not that they are a perfect general case, but the scenario above helps us understand as we adjust the assumptions.
First, with Canada, there are no reserve balances demanded overnight, whatever the interest rate, ever, as a result of these characteristics. The bank of Canada can adjust the target rate with no operations simply by announcing moves in the bid/ask rates. This is obvious. And in the long run, they don’t have to provide any more/less reserve balances regardless of the target rate. Yes, on a day to day basis, they have to stand ready to buy/sell at the bid/ask prices, but those are cleared by the end of the day and the total qty of reserve balances circulating doesn’t change. And we have several years of data that shows Canadian banks still hold 0 reserves within this particular system, regardless of the changes to the interest rate target that have occurred.
If you adjust the assumptions and add RR, you get a positive demand for reserve balances, plus perhaps a buffer to avoid any penalty on insufficient RR. Again, with a target rate change, the CB doesn’t have to do more than announce–RR and the buffer don’t change the moment a target rate changes. Yes, the cb has to stand ready to add/subtract reserve balances if the target doesn’t move (either via operations or by setting the bid/ask), but these must be reversed within the maintenance period since RR were already set and/or preferences for deposits by the public that have RR don’t change that quickly (all well estabilished in the literature). Now, later, the change in the target rate could be large enough to adjust preferences of the public for deposits vs. other assets, or raise/lower bank lending and thus deposits. In this case, as deposits change, the RR changes, too. And as RR changes, the CB must accommodate the increased demand for reserve balances that results or it won’t achieve its target rate. But note that the change in the supply of reserve balances is in response to a later shift in the demand for reserve balances at the given target rate, not an exogenous change in the supply of reserve balances that moves along the demand for reserve balances to a new target rate.
And, most importantly, this entire series of events in the latter example is because of the imposition of reserve requirements–it is not something that is inherent to central banking (as many nations have no RR)–which themselves are well-known now to only be one possible way to stabilize and make predictable the demand for reserves in order to more easily achieve a target rate (not for control of the money supply).”
This all REALLY hammers home the point that it is fundamentally about price, not quantity. Yes it is subtle but it is accurate and does make a difference in thinking about policy and how it is implemented in the real world. Unless you think a central bank is going to completely ignore the payments system and banks’ needs for reserves, not set a discount rate, and let the interest rate on reserves shoot upwards without relent to theoretically infinity.
wh10,
I suppose I should beware of Post Keynesians bearing gifts, but on this point we’re agreement. I’m sure we COULD find plenty of macroeconomic propositions on which we disagree, but on this point we’re on the same page.
It all goes back to a very basic principle of economics: a monopolist can control price or quantity but not both.
@Pilkington
I agree that Nicks semantics discussion were a bit strange (but I do not agree with your examples – I would, generally, call a perfectly competitive market demand determined in the long run and a monopoly market supply determined in the short run.)
@Nick
You probably heard statements like “a man was hit by a car” or “he fucked her”. The later statement signals something else than “he and she fucked each other” or “she fucked him”. Similarly, “a man and a car collided with each other” is not the same thing as “a car collided with a man” or “a man collided with a car”.
So – why would it be a problem to talk about e.g. a demand determined quantity in a perfectly competitive market? I mean, the supply curve (or the representative company) is just laying there, passively, being thrown around due to factors out of its control. Sure, both have to consent, but if one company says “hell no – I am leaving” there is a lot of other companies ready to take its place. On the other hand, if a consumer leaves, one of the existing companies will be without a partner (and do not say that the company should be satisfied with less, it is already living on the poverty line without any prospect of future rents).
However, when it comes to the bad ass monopolist, (s)he is clearly the one who is in control of the situation in the short run. If you are not married to a specific model, you will realize that the quantity on the market will depend on the monopolists strategy, while the consumer preferences (demand curve) stay pretty constant in the short run.
PS: Just realize that I should rewrite the things above from the perspective of “power”, which is sadly lacking in neoclassical economics, but I do not have the time right now.
Yes W Peden!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! Woohoo!!!!! I am sure we could disagree on a lot. I think we have in the past at this very place. Partly why it is refreshing to be in agreement with you :).
BTW Luis, Nick, et al, Fullwiler follows up on the point I am making and Krugman’s response to his piece:
“Update: Paul Krugman has posted a reply to this post that is a straw man. He and Nick Rowe are viewing this all through the lens of the old Monetarist/Keynesian debates in which there was a choice b/n interest rate targets and monetary aggregate targets; the Monetarist critique assumed the Keynesians were going to keep interest rates at the same level forever and not change them. Once John Taylor came up with his “rule,” everyone agreed an interest rate target could work.
What we are talking about here is operational tactics–the CB can only target an interest rate. It cannot target a reserve balances or the monetary base directly. But that is different from strategy–that is, WHERE the CB puts its target and WHEN it chooses to change the target. There is NOTHING in anything I’ve ever said or anything any PK’er, MMT’er, etc., has ever said that suggests the CB can’t set the target wherever it wants whenever it wants. The point is that whatever the target is, THAT is what its daily operations defend directly, not a monetary aggregate, not the monetary base, not reserve balances. There is nothing in anything I’ve said that would preclude the CB from running a Taylor’s Rule type strategy, for instance, that responds at any point in time endogenously to the state of the economy. That is, the target rate is an exogenous control variable (i.e., it is necessarily set by the CB) that it sets endogenously in response to economic events.”
http://neweconomicperspectives.org/2012/04/krugmans-flashing-neon-sign.html
I see this as a battle of logical coherence and robustness in thinking about CB operations. And it is the endogenous money people who have a more coherent and robust explanation on this point. Krugman isn’t thinking it through the whole way, or is at least not being clear about it, and moving the goal posts, as Fullwiler notes.
wh10
looks to me like some talking at cross-purposes. If “official academics” don’t think MS is demand determined in the sense Nick is taking issue with here, fine. If the cap doesn’t fit don’t wear it.
[I don’t think I’ve written anything to suggest I believe in the causal mechanism you ascribe to me (an exogenous change in the supply of reserve balances that moves along the demand for reserve balances to a new target rate) by the way. The story you tell about how “the change in the target rate could be large enough to adjust preferences of the public for deposits vs. other assets, or raise/lower bank lending and thus deposits” sounds to me like what I had in mind when I wrote “[the CB’s] choice of interest rate is a determinant of what actually happens” ]
@ Nemi
Nothing strange about Nick’s semantics argument if you recognise why the rhetorical device was employed. It appears to have been deployed to undermine an unnamed commenter who, apparently, represents endogenous money theory as a whole. It’s a rhetorical cheap shot. Krugman then links to it because he — unconsciously or otherwise — recognises that his prior comments about reserve requirements and money multipliers was wrong. The whole debate can then be compartmentalised and thrown in the bin. The ISLM stays intact. ‘Crowding out’ still means something even though the loanable funds model has been rubbished. And Krugman’s interpretation of the liquidity trap (which is inconsistent even in its own terms) remains a trendy explanation for the current stagnation. Go home folks, nothing to see here.
Regarding the definitions, I pulled them from Wikipedia. They look close enough to the textbook definitions to me. In perfectly competitive markets, according to neoclassical theory, prices are set my the interaction between supply and demand. In monopoly markets there is no supply curve. Price is set by the monopolist and the quantity sold is determined by the level of demand for the good/service in the economy at that preset price. This is precisely what endogenous theorists claim with regards to the quantity of money in a system where the central bank uses interest rate targeting. If Nick found the statement he ‘deconstructs’ in his post difficult to understand he could have looked elsewhere — or he could have emailed one of the endogenous theory writers. But that wasn’t what the semantic argument was about. As I said, it was a rhetorical device. A cheap shot. And anyone who looks at it disinterestedly will see it as just that.
Determinant is, as usual, correct about LTVS. But the statement “no RTGS in Canada” has mislead Sergei.
Payments made with LTVS are made in real time. Once made, the are irrevocable, and have zero probability of failing. A payment can be spent immediately after it has been received. Two entities who are not members of the LTVS can transfer large sums between each other in real time with 100% confidence through the agency of LTVS members.
What is settled daily are the net balances of LTVS members – obviously you cannot net without a time interval over which to accumulate payments. How can payments be guaranteed in real time when they are net settled hours later? There are three components to the guarantee.
First, the net position of every LTVS member is tracked in real time, payment by payment, and every member has both unilateral and multilateral limits on its net exposure. It is impossible to initiate a payment that exceeds these limits. LVTS members have the ability to set bilateral limits with each other.
Second, every LTVS member must post collateral daily; the total amount of this collateral is set so that it is at least enough to cover the largest possible net exposure of any one member. Should that member fail, the collateral posted by the other members is the first recourse.
Finally, the Bank of Canada is contingently liable to cover the excess exposure over the collateral account should more than one member fail simultaneously. It is able to guarantee this completely because it can create money as required.
@dwb:I think your 11.03 comment were very clearly written, so I am going to steal the format.
The puppetmaster (cb) does not control the puppets (money supply, credit, aggregate demand, investments, inflation), the puppetmaster controls the strings (interest rates) which have an effect on the puppets.
Most people would agree money is endogenous if rates are fixed. CB sets an interest rate – thus, money is endogenous.
The interesting monetarist question is not what instrument the CB should use. Technological development has made it pretty much impossible to control anything through some money supply rule. Every modern CB sets the interest rate.
The interesting monetarist question is what the CB should target (inflation, unemployment, NGDP) and which interest rate (rule/path) they should adopt to achieve it (possible sprinkled with some unconventional monetary strategies for the lower zero bound)
Philip Pilkington:
1. I wasn’t even pretending to define supply and demand.
2. Wiki is wrong on the definition of supply. Yes I know it’s the same as Greg Mankiw’s definition, but that’s wrong too, as can be seen if a price floor puts price above market-clearing and you ask if the sellers are able to sell what they are willing to sell. (Yes, I’m being picky here).
3. Wiki is correct that a profit-maximising monopolist doesn’t have a supply curve, because quantity supplied is a function of the elasticity of demand, and not just price alone, but it still has a supply function, which includes elasticity of demand as one of its argument.
4. Yes I am being picky about semantics in this post, because sometimes it matters. And it matters a lot in this case, because if I say “suppose the Bank of Canada changes the supply of money” and someone reads “supply” as a number, and says the Bank of Canada doesn’t set the supply of money, we will be arguing at cross-purposes. Plus, I rephrased the other side’s position to make it semantically correct, so I was not attacking a straw man.
5. Mind your manners please, on my blog posts.
@ Nick Rowe
You didn’t source the quote. The quote “The supply of money is demand-determined” is not what Fulwiller or Keen said, as far as I can see. So, it’s not clear whose semantics you’re attacking.
My point is that I can attack your post semantically if I want — and it wouldn’t be hard; it rarely is because once you deal with semantics you no longer have to take other people’s arguments in good faith; you don’t have to try to see the substance of what they mean. But I don’t think its a valid method of argument. It aims at the language of the argument rather than the substance.
I don’t think I’m being remotely rude here. This is a well-known rhetorical tactic. Remember the Sophists? That’s what they used to do. They would pick at linguistic constructions rather than engage with the substance of the argument.
@Phil Koop:
Thanks, my thoughts exactly.
@Sergei:
All the pertinent details are contained in that book about the Canadian Payments Association. We have a Deferred Net Settlement System, as Phil so ably said, and that choice was based on institutional preference and cost.
Actually, I just did a Google search of:
“The supply of money is demand-determined”
Only got one clean hit. This blog. Closest I got from the PK crowd was from an academic paper by DI Fand:
“..the supply of money as horizontal at a given interest rate, and the stock of money is therefore completely demand determined.”
Someday, maybe the neoclassicals will actually debate the endogenous money people. Someday.
I have to admit, I found this post pretty tricky to disentangle. I’m also not convinced that demand and supply curves easily capture the nuances. But it seems to me Nick’s argument is thus:
– on a six week time horizon, the money stock is “demand determined”, in the sense that the BoC sets an interest rate at which it supplies reserves on demand
– on a longer time horizon, the BoC targets inflation, and adjusts the policy rate to hit the target. The short run horizontal supply curve thus moves up/down as necessary
– therefore, in the long run, the money stock in inflation elastic, in that the BoC is happy to let it rest at whatever level is consistent with the inflation target
So far so good. I understand this as saying that while the money stock is endogenous, in the sense that reserves are supplied at the prevailing policy rate according to demand, the inflation target is in fact a form of meta-constraint on money growth, as too high/low a level of inflation relative to the target will induce rate changes that affect money growth. This all seems pretty straightforward, and I don’t really see a problem accepting this broad argument.
But – I don’t see any particular reason to believe that a given inflation target implies a unique (or more weakly, a predictable) path of money growth. The inflation-consistent level of money growth could surely depend on many factors …. structural changes in the credit markets, behavioural changes that induce velocity changes, or indeed the impact on inflation of other factors such as commodity price changes, or smaller/larger fiscal impulse from government spending.
Oh, and just to add to my post above … if the economy is has slack, underused capacity, a monetary expansion does not necessarily imply proportionate price rises. What am I failing to get here ?
@nemi (1:10pm): yes, the intersting question is what the target should be and what instruments the cb should use.
@wh10: i dont see the answer in any of Fullwiler’s posts. They say the cb chose interest rate targeting to minimize volatility at the maturities relevant for economic decisions. great. I agree. The question posed is: Assume the cb no longer targets rates (which many people would say the cb should not do) and instead targets reserves, HOW does the target rate affect the aggregate amount of credit/savings/investment/consumption in the economy. Since the quote seems to indicate that interest rates become volatile, that must mean reserves become scarce.
Interestingly, Fullwiler says: “Absent interest on reserves at the target rate, a central bank would not be able to achieve its target rate if it employed the money multiplier model and tried to directly target reserves.”
is this the loophole in MMT? can the CB employ the hot potato effect (money multiplier) if it employs interest of reserves?
Sounds pretty orthodox to me: the central bank can target reserves and its target rate if it also pays interest on reserves (interest on reserves controls demand).
@Nick, I think you forgot that it is a decision on the part of the monetary authorities where to set the overnight interest rates always. You are used to thinking of it in terms of a response to economic conditions, taylor rule or whatever, but if you go a step back, they chose to use that rule, they were not forced to by markets. It always is a choice, now six weeks from now, a year from now whatever.
Now stepping forward, there were attempts in the US and UK by the monetary authorities to target the monetary base. They failed for reasons you should know by now after all of our discussion. I did a little research and found the moment when the Volker Fed realized it was futile to hit their MB target, they missed it by a long shot and nearly broke the payment system (the fed funds rate spiked to 26% some days with a zero with no bid offer!), all they can do is hope to influence the MB with their choice of interest rate:
Click to access FOMC19800916meeting.pdf
MR. WALLICH. Do you use a monthly model or do you use some
relationship between the funds rate and the level of borrowing?
MR. STERNLIGHT. I don’t think it’s that–
CHAIRMAN VOLCKER. We don’t have that pseudo-precision.
…
CHAIRMAN VOLCKER. The Desk can’t [adjust] in the short run. It’s fixed. In a sense they could do it over time if people are borrowing more, as they may be now. They seem to be borrowing morethan we would expect, given the differential from the discount rate. But in any particular week it is fixed.
MR. ROOS. Do we have to supply the reserves?
CHAIRMAN VOLCKER. We have to supply the reserves.
MR. ROOS. [Why] do we have to supply the reserves? If we did not supply those reserves, we’d force the commercial banks to borrow or to buy fed funds, which would move the fed funds rate up. What is lurking in the back of my mind is this: Are we, in effect, frustrating our ability to achieve what we want with the aggregates and with reserves because of possible concern about fluctuations in the fed funds market? In other words, do we accommodate that problem?
CHAIRMAN VOLCKER. We can force [the depository institutions] to borrow more in a given week, but we can’t force the level of reserves lower.
MR. WALLICH. Yes, but by forcing them to borrow more, we are raising the funds rate. And the question here is: Are we in that more distant sense back on a funds rate target?
MR. ROOS. You said it, Henry!
MR. AXILROD. Governor Wallich, as you know, with lagged reserve accounting there is simply nothing we can do in the current week other than determine the level of free reserves in the banking system with open market operations, given required reserves. And to the degree that there is a relationship–and it’s pretty loose these days–between free reserves and interest rates, we are in some sense in the short run determining the funds rate. But in the longer run, of course, it’s the market movement in the money supply relative to our target that will determine the funds rate.
And of course to quote Wray “In many nations, such as Canada and Australia, the promise of an overdraft is explicitly given, hence, there can be no question about central bank accommodation because banks can borrow reserves on demand at the central bank’s target interest rate.
I think we’ve established pretty what a CB can and can’t do with regard to interest rates and monetary base. We’ve established what CBs actually do! Have we mystics made our case yet?
rjw: “But – I don’t see any particular reason to believe that a given inflation target implies a unique (or more weakly, a predictable) path of money growth. The inflation-consistent level of money growth could surely depend on many factors …. structural changes in the credit markets, behavioural changes that induce velocity changes, or indeed the impact on inflation of other factors such as commodity price changes, or smaller/larger fiscal impulse from government spending.”
Agreed.
“… if the economy is has slack, underused capacity, a monetary expansion does not necessarily imply proportionate price rises. What am I failing to get here ?”
Not much. You could argue that a monetary expansion would imply proportionate price rises relative to what would have happened otherwise (which could have been price falls).
OK, inflation has been higher in several euro member state then the ECB rate. If you argue that interest rate is endogenous variable, then is It endogenous variable in Euro member states too?
Kristjan: Roughly speaking (e.g. ignoring risk, which is rather hard at the moment!), it’s exogenous wrt a small individual Eurozone country. It’s endogenous for the Eurozone as a whole.
Tschäff Reisberg,
The UK did attempt to target the monetary base (M0) but not when most people think they did and not as an exercise in monetary base control. M0 targets had their greatest period of prominence from late 1985 to early 1988, when M0 was used as an indicator; the demand to hold M0 was falling rapidly at the time and it was hopeless in indicating the overheating in the UK economy that began in 1986.
The monetary base played almost no role in the chief failure of the monetarist period in the UK, which was 1980. At that time, the (broad) money supply was supposed to be targeted primarily through fiscal policy and interest rates. Significantly, there was a move away from quantitative control in this period, which (along with deregulation) was a key factor in the exceptional change in the demand for money in the 1980-1981 period as there was “re-intermediation” back into M3 and M4 balances.
Tschaff
Thanks for the link – it’s fascinating. I don’t think it proves what you think it does, but thanks!
Nick, when people say that the money supply is demand determined, they aren’t talking about the ‘demand for money’. They are referring to the effective aggregate demand of the economy. When the economy is growing quickly (i.e. there is growth in aggregate demand) then some of that demand will be satisfied by an increased demand for credit and those loans will in the first instance be delivered in the form of a bank deposit. This is why post-Keynesian economists argue that it isn’t money supply that determines inflation any relationship between the two is a product of both money supply and inflation being response to aggregate demand. Prices are set by supply and demand. If the total demand within an economy for some goods, services or resources exceeds the economy’s ability to satisfy that demand (the capacity to supply goods, services or resources), then prices of those goods, services or resources will rise.
David: “Nick, when people say that the money supply is demand determined, they aren’t talking about the ‘demand for money’. They are referring to the effective aggregate demand of the economy.”
Hmmm. Are you sure? Why don’t they just say “The stock of money is determined by Aggregate Demand”?
Nick: “Are you sure? Why don’t they just say “The stock of money is determined by Aggregate Demand”?
Others may disagree, but in my view monetary aggregates aren’t usually seen as very important by post-Keynesian economists (more a symptom than a cause). And the ‘demand’ for how much people hold in what we arbitrarily denote as money rather than longer-term financial obligations isn’t a determinant or demand or pricing, and therefore not a very meaningful statement. The furthest someone who claims to believe in the endogeneity of money might be willing to push it is that money is ‘largely’ determined by the ‘demand for credit’, but again that is just a proxy for effective aggregate demand. Chapters 2 through 4 of ‘A handbook of alternative monetary economics”, which is a collection of papers on monetary economics edited by Philip Arestis and Malcolm C. Sawyer, are the best place to get a more definitive answer.