It is a cliche (among economists) to say that expectations matter. It is even more of a cliche to say that expectations matter for asset prices. But how much do expectations matter? I'm going to do a quick and dirty back of the envelope calculation to show that expectations matter a lot. And that the lower are interest rates, the more expectations matter.
Then I'm going to remind people that money is an asset. Then I'm going to remind people that recessions are always and everywhere a monetary phenomenon, and that recessions are an excess demand for money. So expectations of future monetary policy matter a lot for recessions. Especially when interest rates are low.
Take an infinitely-lived bond that pays a coupon of $1 per year. If the market rate of interest is 5% per year, the market price of that bond will be $20. Suppose the current annual coupon payment is lost, due to an accident that people expect will never be repeated. The value of the bond drops to $19. Only 5% of the value of the bond depends on what happens this year. The remaining 95% of the value of the bond depends on what is expected to happen in future years. (The proportion would rise to over 99% if coupons were paid monthly and we were talking about future months.)
Take the same bond, but now assume the market rate of interest is 1% per year. The market price of the bond will be $100. The loss of the current year's coupon, if expectations of future coupons are unaffected, will drop the price of the bond to $99. Now 99% of the value of the bond depends on expectations of future years.
Expectations matter a lot for the demand for long-lived assets, and hence for the price of long-lived assets. The lower the rate of interest, the more expectations matter. What happens this year doesn't matter very much at all (unless it affects expectations of future years), and it matters even less as the rate of interest gets lower.
Money is an asset. It's also a very long-lived asset (unless inflation is high). The demand for money, and the equilibrium price of money, depend, like all assets, much more on what is expected to happen in future years than on what happens this year. That is even more true when interest rates are very low. Interest rates are very low now.
Recessions are always and everywhere a monetary (medium of exchange) phenomenon. Recessions are an excess demand for money (the medium of exchange). The demand for money is the demand for an asset. Since the demand for money, like the demand for all assets, depends very much on expectations, especially when interest rates are low, recessions depend very much on expectations too, especially when interest rates are low.
This is for Chris Dillow, who says "@ Nick – you've raised one of my beefs with NGDP targets – that relying upon expectations to do work is to rely upon a weak lever." (with a big HT to Left Outside who also has a good example to show how monetary expectations matter). (And it's also for the people of the concrete steppes).
Worthwhile Canadian Initiative 
I can’t buy this, Nick. It seems like the old “shortage of money” account of economic destitution – which I think Hume effectively refuted way back in “Of Money”.
Broad money is generated endogenously within the economy, as needed, in response to opportunity. If an entrepreneur has an opportunity to turn some real resources into something of greater value, and make a profit from the sale of what is created, and he makes a convincing case that he can do so to a banker, then the banker will supply the money the entrepreneur needs on the spot in return for interest in the profits. If bankers do not want to to this, its not because to many people are hoarding the money that already exists – since they don’t need the money that already exists – it’s because the entrepreneur can’t make a convincing case that he will profit. And the reason he can’t make a convincing case that he will profit. And he can’t make such a case if his customers are impoverished.
Leave out my second-to-last sentence.
Hume was wrong. A banker, or any other business person, can shift from “profit-maximization” mode, where increased profit equals increased risk, to “balance-sheet preservation” mode where additional risk is unwelcome as it would injure the balance sheet and imperil the firm.
In the first case the income statement is more important than the balance sheet, in the second the balance sheet trumps the income statement.
You can’t talk to a banker about risk who can’t look past his balance sheet, he’s not crazy, just on a different page. His needs and your needs no longer coincide and it has nothing to do with you.
Dan: seriously. Re-read Hume. Of Money. The reason why Hume thought a halving of the stock of money wouldn’t matter is because he thought that, in the long run a halving of the stock of money would cause a halving of the price level. Then read that bit about how a change in the amount of money does matter in the interim between the increase in the stock of money and the increase in prices, where even the ploughman follows his plough with greater diligence, and how it is the good policy of the magistrate to keep the stock of money increasing (Hume loses it a bit here). It is in the open economy version, Of the Balance of Trade, where Hume invokes the price-specie flow mechanism to say that the stock of money is endogenous (to an individual country on the gold standard).
Hume:
“If we consider any one kingdom by itself, it is
evident, that the greater or less plenty of money is of no
consequence; since the prices of commodities are always proportioned
to the plenty of money, and a crown in HARRY VII’s time served the
same purpose as a pound does at present.”
A clear statement of the Quantity Theory of Money and the (long run) neutrality of money.
“But notwithstanding this conclusion,
which must be allowed just, it is certain, that, since the discovery
of the mines in AMERICA, industry has encreased in all the nations of
EUROPE, except in the possessors of those mines; and this may justly
be ascribed, amongst other reasons, to the encrease of gold and
silver. Accordingly we find, that, in every kingdom, into which money
begins to flow in greater abundance than formerly, every thing takes a
new face: labour and industry gain life; the merchant becomes more
enterprising, the manufacturer more diligent and skilful, and even the
farmer follows his plough with greater alacrity and attention…..”
A clear statement of the empirical short run non-neutrality of money.
“To account, then, for this phenomenon, we must consider, that
though the high price of commodities be a necessary consequence of the
encrease of gold and silver, yet it follows not immediately upon that
encrease; but some time is required before the money circulates
through the whole state, and makes its effect be felt on all ranks of
people.”
A clear statement of the reason for that short run non-neutrality: it takes time for prices to adjust.
“Broad money is generated endogenously within the economy, as needed, in response to opportunity.”
A fascinating assertion, since it implies (1) no monetary disequilibrium; (2) no central bank or base money (assuming you’re defining, dubiously, ‘the economy’ as the non-government economy); and (3) the absence of any relation between central bank activites, asset prices and “opportunities”.
Apart from that, it’s on the right lines.
BTW: when Hume says
“It is only the public which
draws any advantage from the greater plenty of money; and that only in
its wars and negociations with foreign states.”
By “the public” he means “the government”. A country with a large stock of gold, and high prices, relative to other countries, will be able to fight wars overseas and bribe foreign governments more cheaply.
Nick, I’m not talking about the part of Hume’s essay where he talks about what would now be called the short-run non-neutrality of money. I’m talking about the later section in which he discusses the supposed problem of shortages of money, particarly with respect to agricultural regions. He argues that the whole idea of a shortage of money is a mis-diagnosis of the phenomenon of economicunderdevelopment.
But in our time,with metallic money or standards playing no real role, and having adopted the paper credit money that Hume deplored, the whole idea of a shortage of money as the source of economic underperformance makes even less sense. The central bank has adopted a wildly accommodative stance with respect to the supply of reserved which are the modern day “gold” upon which bank credit is written. This base money can be manufactured at will and is available to banks at a fraction above 0%! Any borrower who can make the case that he has an enterprise that will not lose money can get this money at a song. There is no shortage of money or tight money or cold potato money. It’s not about money! It’s about real resources and goods and their distribution. The capitalists have impoverished the human foundation of the economy and indentured them to the owners of property. No wonder they can no longer support the level of demand needed to produce growth.
Since the economy cannot strongly support the injection of purchasing power in the form of credit – because of a shortage not of money, but of credit-worthiness – then the only way to inject purchasing power into the economy is to force feed it in by direct government action. There is no money-master in our world. The central banker can’t push money out into the economy via the money multiplier that doesn’t exist. If there is insufficient credit worthiness at the zero bound, then the central banker can’t manufacture it. There is no monetary hot potato – the very idea is ludicrous. And the central banker is also not some kind of national party master or expectations Svengali that can stoke or hypnotize people into spending – especially spending resources they don’t have.
For people who are so convinced that the key to the problem is money, you monetarists are remarkably reticent about advocating the steps that could actually work to inject money directly into the sick economy: having the people’s representatives vote to use their inherent monetary authority to spend money directly into the economy, including by hiring some of the millions of unemployed to do some of the millions of public services we need done that are not getting done. Why not? Is it that you take your marching orders from Scott Summer who is a stubborn right Wong ideologue who hates democracy and is terrified by the idea of the people taking control of their own economy and wresting it from impotent central bankers and their authoritarian fan clubs of economists who dream of controing the world from a single panel led office?
I’m a little weary of the constipated kvetching of the NGDP club. Too me you guys are starting to seem like a bunch of guys locked in a bathroom and railing at the world over the tightness of your own sphincters. Open the door and step outside. There is a lot more broken out here than the brainwave machine connecting our minds to the alpha waves of Ben Bernanke.
Now I think I’ll go home and have a laugh with my wife about the fact that there are these guys out in the blogosphere who think the reason we have not bought much stuff lately is that we have suddenly developed a strange desire to “hold” too much money. My co-workers will also get a kick out of the idea that that is why we didn’t get raises this year. My company sells books. And you know what. I think if we were paid in books, we wouldn’t have gotten more of them this year either.
Dan Kervick,
Would you agree then that the time has come to buy up and retire the US national debt? People are indifferent between government bonds and base money right now, so it won’t make any difference except to make future debt expansion easier and to eliminate any remaining interest payments by the US government.
Sorry about all the typos. I typed the above on my iPhone where I’m even worse than usual.
W. Peden,
So that would amount to a kind of quantitative super-easing, right, with years of interest payments scrunched up into the immediate term? Couldn’t that cause more of the asset-market distortions that (I think) we have already?
How about if we just transferred the obligation to pay the debt to the Fed, which they can then do on the existing schedule, by marking up bank accounts as needed, without collecting a dime of taxes or borrowing any additional funds?
“It is a cliche (among economists) to say that expectations matter.” – (Nick’s opening sentence).
Quite right: I suspect there is more cliché here than empirical evidence.
Expectations are doubtless important in some cases. For example as W.Peden pointed out a few days ago, union leaders think carefully about future inflation when framing wage demands.
But there are other instances where economists assume expectations are important where I have big doubts. For example, it is often assumed that given rising government debt, households will assume that means future tax increases so as to repay the debt. Thus households will allegedly rein in spending given rising government debt.
I doubt it. But empirical evidence beats everything else. I’ll be persuaded when I see the evidence.
”
Broad money is generated endogenously within the economy, as needed, in response to opportunity.”
A fascinating assertion, since it implies (1) no monetary disequilibrium; (2) no central bank or base money (assuming you’re defining, dubiously, ‘the economy’ as the non-government economy); and (3) the absence of any relation between central bank activities, asset prices and “opportunities”.
Apart from that, it’s on the right lines.”
These aren’t contradictory. Interest rates and availability of risk-free collateral (for repos) and cost of funds (for banks) affect these “opportunities”, and the Fed strongly influences these.
Anybody can create money. It’s finding people who’ll accept it that’s hard. Linden dollars are money, and they can only be used inside Second Life. Still, if you search you’ll find quotes for conversion to and from dollars. There are people make a living earning Linden dollars inside Second Life. There’s also whole industry in China of people playing computer games to get game money and weapons to exchange for dollars.
A fascinating assertion, since it implies (1) no monetary disequilibrium; (2) no central bank or base money (assuming you’re defining, dubiously, ‘the economy’ as the non-government economy); and (3) the absence of any relation between central bank activites, asset prices and “opportunities”.
I’m not denying the existence of base money, but just claiming that loans create deposits, and deposits create reserves. The central bank influences the pace of creation somewhat by targeting an interest rate. But when interest rates are already near zero, I don’t think you can make much sense out of the idea that continuing unemployment and underproduction are due to monetary phenomena, since genuine opportunity will call into existence its own financing.
Peter N,
“Interest rates and availability of risk-free collateral (for repos) and cost of funds (for banks) affect these “opportunities”, and the Fed strongly influences these.”
But I thought that the money was provided as needed?
“Anybody can create money.”
If you mean anyone can get a line of credit, then no. If you mean anyone can create a deposit, then no.
Dan Kervick,
“So that would amount to a kind of quantitative super-easing, right, with years of interest payments scrunched up into the immediate term? Couldn’t that cause more of the asset-market distortions that (I think) we have already?”
Elaborate on “distortions”, please. How can swapping one asset for another change anything?
“How about if we just transferred the obligation to pay the debt to the Fed, which they can then do on the existing schedule, by marking up bank accounts as needed, without collecting a dime of taxes or borrowing any additional funds?”
Just eliminate the debt. Then there will be no case that fiscal hawks can mount against increased spending: the public debt-to-GDP ratio will be 0%, which is as good a place to increase spending as any.
“I’m not denying the existence of base money, but just claiming that loans create deposits, and deposits create reserves.”
I think the word ‘create’ is being put to a bit of creative use here. “Loans create deposits” is a vague way of saying that commercial banks buy assets (which can be equity or can be bonds, so talking about “loans” is somewhat descriptively incomplete) through creating deposits. OK, though “Banks create deposits” is much more to the point and doesn’t suggest a pseudo-causal story.
However, “Deposits create reserves” is entirely too sloppy. A deposit is a claim on reserves. For that claim to be met, the reserves have to be obtained at a price. Now, I know that you know this, but now you know that I know this, so now we both know that we both know this, we can actually get into the real points of the matter, like monetary disequilibrium and asset prices.
“But when interest rates are already near zero, I don’t think you can make much sense out of the idea that continuing unemployment and underproduction are due to monetary phenomena, since genuine opportunity will call into existence its own financing.”
Go back to the scenario where the entire US public debt has been bought by the central bank. I assume that people hold bonds because there is a demand for bonds. I assume that, if the supply of X goes down and the demand for X stays the same, then the price of X rises. Call it a “market distortion” or even a “price mechanism” or even “a market”. Are we together this far or have I made some unwarranted assumptions?
Elaborate on “distortions”, please. How can swapping one asset for another change anything?
Possibly not that much. If you buy an asset with cash that was due to deliver interest payments on a fixed schedule over several years, then in principle the seller is now more liquid and will look for something to do with that cash – like speculate in commodities. But if the two assets are of roughly equal present value, and the interest-bearing asset was already very liquid, then perhaps it really doesn’t matter much.
“Loans create deposits” is a vague way of saying that commercial banks buy assets (which can be equity or can be bonds, so talking about “loans” is somewhat descriptively incomplete) through creating deposits.
I’m talking about the fact that the loans banks make to their customers create deposits. Customer comes in, asks for a loan. If the bank decides the loan will be profitable, then bang, they create an account for the borrower and credit it with a balance. They don’t have to acquire funding first. If they subsequently need to acquire additional reserves, they do so.
Go back to the scenario where the entire US public debt has been bought by the central bank. I assume that people hold bonds because there is a demand for bonds. I assume that, if the supply of X goes down and the demand for X stays the same, then the price of X rises.
That seems right to me. What do you conclude form this?
Dan Kervick,
“Possibly not that much. If you buy an asset with cash that was due to deliver interest payments on a fixed schedule over several years, then in principle the seller is now more liquid and will look for something to do with that cash – like speculate in commodities. But if the two assets are of roughly equal present value, and the interest-bearing asset was already very liquid, then perhaps it really doesn’t matter much.”
Like I said- we can eliminate the whole US national debt tomorrow by simply swapping it for base money. It’s a scandal that we’ve had so many zero-rate enviromments in recent years and not one country has taken this small harmless step.
“I’m talking about the fact that the loans banks make to their customers create deposits. Customer comes in, asks for a loan. If the bank decides the loan will be profitable, then bang, they create an account for the borrower and credit it with a balance. They don’t have to acquire funding first. If they subsequently need to acquire additional reserves, they do so.”
The way you put it there, I would be more inclined to say “Customers and banks make deposits when they agree on loans”. Which is true. (Deposits are also created when banks use them to buy corporate or government bonds.)
Anyway, like I said, you know this and I know this and you know that I know that we both know this. It isn’t where we disagree.
“That seems right to me. What do you conclude form this?”
So let’s go to step 2: banks are in the business of acquiring assets. Go back to the bank customer: banks need to take into account both (1) what kind of profit they will get by lending at a given set of terms and (2) the credit-risk of that customer. If we think about the effects of asset prices on (1) and (2), we can see that expected higher asset prices make it more profitable to invest in assets, while customers who can offer higher-priced assets as collateral are less risky to lend to. Additionally, remember the role of the customer in the process: people will be more willing to buy a house, for instance, if they expect the value of that house to increase strongly.
Given that we know that banks lend to creditworthy customers* (where potential returns are thought to be greater than expected risk of default) and given that assets prices have an unbounded effect on (1) and (2), what should we expect to occur if the price of interest-bearing assets is increased by a reduction in their quantity?
* Here “customers” includes sellers of bonds as well as people getting out loans, because it’s always worthwhile avoiding thinking just in terms of either businesses or households or the government; all three can obtain credit from banks.
Dan: Hume is there talking about barter and peasants who grew their own). And princes collecting taxes in kind too. (Obviously he hadn’t read Graeber):
“There are some
kingdoms, and many provinces in EUROPE, (and all of them were once in
the same condition) where money is so scarce, that the landlord can
get none at all from his tenants; but is obliged to take his rent in
kind, and either to consume it himself, or transport it to places
where he may find a market. In those countries, the prince can levy
few or no taxes, but in the same manner: And as he will receive small
benefit from impositions so paid, it is evident that such a kingdom
has little force even at home; and cannot maintain fleets and armies
to the same extent, as if every part of it abounded in gold and
silver.”
Hume’s own proposed monetary policy:
“From the whole of this reasoning we may conclude, that it is of no
manner of consequence, with regard to the domestic happiness of a
state, whether money be in a greater or less quantity. The good policy
of the magistrate consists only in keeping it, if possible, still
encreasing; because, by that means, he keeps alive a spirit of
industry in the nation, and encreases the stock of labour, in which
consists all real power and riches. A nation, whose money decreases,
is actually, at that time, weaker and more miserable than another
nation, which possesses no more money, but is on the encreasing hand.”
And here’s Hume talking about the effects of people hoarding money being equivalent to a reduction in the total supply of money:
“It is also evident, that the prices do not so much depend on the
absolute quantity of commodities and that of money, which are in a
nation, as on that of the commodities, which come or may come to
market, and of the money which circulates. If the coin be locked up in
chests, it is the same thing with regard to prices, as if it were
annihilated; if the commodities be hoarded in magazines and granaries,
a like effect follows.”
Hume sounds a lot closer to Scott Sumner than to MMT.
Ralph: “Quite right: I suspect there is more cliché here than empirical evidence.”
Think about asset prices. A freehold house costs more than a 99-year lease, which costs more than a 1 year lease. The only difference is different expectations about the value of the right to live in that house 2 years from now and 100 years from now. That is empirical evidence that expectations matter.
Most people change their car’s oil, because they expect that if they don’t the car will stop working sooner.
I can imagine a world in which expectations of the future didn’t matter. There would be zero saving and investment in that world.
@W Peden
“But I thought that the money was provided as needed?” At the asking price to those with good credit. Who said it was free? The point is it isn’t rationed, and deposits don’t come first. Even the broadest of broad money isn’t free.
“If you mean anyone can get a line of credit, then no. If you mean anyone can create a deposit, then no.”
I’m afraid I was using money in a different sense. When you talk about banks creating money, your talking about deposits by implication in a fractional reserve system that works like the US one (not all do).
When I say anyone can create money, I mean anyone can create a medium of exchange, store of value and unit of account. If he can persuade others to use it, it’s money. If it’s convertible to dollars and has a useful ambit, then it’s useful money. There’s lots of it out there, created by different people/organizations, usually for use within a community and because it avoids onerous regulations – gambling, taxes, banking, need to control the community money supply and prevent inflation…
So I can deposit a deposit indirectly by converting currency, But I can’t create one by this means in the currency of the deposit. This has, of course no effect on the money supplies in either currency.
There’s a ton of it, once you start looking.
What if expectations are based on “Future demand”? and NOT inflation?
If my business forecast show that I am operating at 70 percent of capacity and demand is flat, I am NOT going to expand no matter what the interest rates. Unless some one pays me to expand or BigG buys a lot of product, the risk for Return on Investment will be too high. What many seem to not understand is that Return on Investment (and associated risk) is a function of DEMAND. When demand tanks, as it has in this depression, Risk SKYROCKETS. Money is an asset. Capacity is an asset. Excess capacity can have NEGATIVE return on investment. Money at Zero percent real interest is better to hold than Excess capacity at negative return.
What needs to change is not the inflation expectations, but the Demand expectations. The idea that we will have inflation when labor is in over supply and most products are in over supply is laughable. This is why it is so hard for monetary policy to raise expectations without help on the demand side from fiscal policy. Fiscal policy must increase the demand for labor or the demand for goods and services for monetary attempts to increase inflation expectations to be halfway credible.
-jonny bakho
” A freehold house costs more than a 99-year lease, which costs more than a 1 year lease. The only difference is different expectations about the value of the right to live in that house 2 years from now and 100 years from now. That is empirical evidence that expectations matter.
Expectations matter but the NPV of a house 99 years from now is effectively 0. You have additional rights with a freehold, a different tax status and the freehold is better collateral. That’s enough for a price difference.
What’s the difference in value between a 99 year lease and a 199 year lease? Not much, I’d think.
Peter N,
“At the asking price to those with good credit. Who said it was free? The point is it isn’t rationed, and deposits don’t come first. Even the broadest of broad money isn’t free.”
If money is anything other than free, then there can be more or less of it than needed. Compare this to, say, Nicholas Kaldor’s model of endogenous money where money is always in equilibrium as it adjusts automatically to the terms of trade.
“I’m afraid I was using money in a different sense. When you talk about banks creating money, your talking about deposits by implication in a fractional reserve system that works like the US one (not all do).”
Sure…
“When I say anyone can create money, I mean anyone can create a medium of exchange, store of value and unit of account. If he can persuade others to use it, it’s money.”
So it’s not quite the case that “anyone can create money”, but rather anyone of who can persuade others to use something as money can create money. Anyway, we’re getting a bit pedantic and esoteric here.
The money that is an asset to one person, is a liability on a bank’s balance sheet somewhere. (Think about finding a purse with a gold coin and a French franc note in it.). So recessions could be an unwillingness to hold the liability, rather than an excess demand for the asset.
“Money is an asset. It’s also a very long-lived asset (unless inflation is high).”
This confuses me. Would you say that an overnight loan is a very long lived asset? Well, that’s what “money” (e.g. bank account) is, right?
W Penden,
We can retire the debt with a Trillion Dollar Coin, or a series of Coinz. We talk about this over at monetary realism.
I agree with Dan K. Instead of giving some mental telepathy to get spending going by increasing lending, why not just give actual poor people money? There is no expectation of future good times necessary to get more spending. For people in the lower 40% of the income distribution, just giving them money would be enough to induce spending.
@Determinant:
Hume was wrong. A banker, or any other business person, can shift from “profit-maximization” mode, where increased profit equals increased risk, to “balance-sheet preservation” mode where additional risk is unwelcome as it would injure the balance sheet and imperil the firm.
In the first case the income statement is more important than the balance sheet, in the second the balance sheet trumps the income statement.
You can’t talk to a banker about risk who can’t look past his balance sheet, he’s not crazy, just on a different page. His needs and your needs no longer coincide and it has nothing to do with you.
well, lets talk to a banker familiar with credit models: a banker these days will say that preservation of the balance sheet and profit maximization are the same thing. preservation of the balance sheet (capital) means minimizing losses, generally because unemployment is high and delinquencies are large. minimizing losses is the same as maximizing profit.
The only “switching” going on is from recession to growth.
Lowering unemployment has the dual effect of reducing delinquencies/defaults and presenting additional loan growth opportunities.
http://research.stlouisfed.org/fred2/graph/?g=71h
same data on a scatter plot (unfortunately FRED does not let me condition on negative home prices and use the quarterly series, but this illustrates the point):
http://research.stlouisfed.org/fred2/graph/?g=71i
Mike S,
Absolutely: in a liquidity trap, it’s a scandal that we haven’t totally monetised the debt (although this wouldn’t have any effect whatsoever on aggregate demand, because it would just be an asset swap). We can conclude that the Obama administration and the UK Labour/Coalition governments are the most fiscally incompetant governments in all of history for ignoring this costless way of retiring all the national debt forever.
(It’s rather fun to drive this liquidity trap malarky to absurdity.)
As for giving money to the “poor”: what do you do when you want to cool down the economy? Take that money from the bottom 40%? And what do you buy from them?
Max: “”Money is an asset. It’s also a very long-lived asset (unless inflation is high).”
This confuses me. Would you say that an overnight loan is a very long lived asset? Well, that’s what “money” (e.g. bank account) is, right?”
A lovely question. I like that one. It made me think. (I am not being sarcastic, just in case it sounds like it.)
A house is a long-lived asset. What about an IOU for delivery of one house one day from now? Would we call that IOU a long-lived asset? Well, the value of that IOU will depend on the value of the house many years from now. If you learned the house had untreatable woodworm, and would fall down 50 years from now, that would reduce the value of the overnight IOU. Now imagine a second IOU that promised to pay the first IOU tomorrow. Same thing. Now imagine a sequence of such IOUs, stretching off into the distant future. The value of the current IOU depends on the second, which depends on the third, etc.
Gotta go. Back later.
@jonny bakho
I agree with a lot of what you are saying but disagree with the conclusion. Let me offer the observation:
The CFO of your company gets the new quarterly economic presentation from Goldman Sachs (who helps them place the bonds to buy the factory). It says:
Now, you are in a competitive industry and dont want to lose market share. You place a 30% probability that this will work. However, the stock and bond market took off, so certainly other people feel this will work. Since you dont want to lose market share you update your business plan given your 30% probability weighted forecast and ramp production somewhat to build some inventory, using overtime. So does your competitor.
The overtime wages paid flow back into the economy (and your workers feel more confident so they spend more), some of which ends up as higher demand for your product confirming some of your forecast. By the way, not all sectors of the economy are at 70% capacity, some are growing (like health care, just slower than trend) and some growing rapidly (ipads).
As the multiplier effect kicks in, your probability weighting that this will work goes up and you actually hire some people.
The Fed may or may not have to buy assets to prove its committment (probably).
Nevertheless, in the US here we have circa 4.5% growth right now with a fiscal contraction. So certianly 5 or 6% is feasible with more Fed stimulus.
Yes, Nick, and Hume also imagined helicopeter drops, at least as thought experiments. Now in our time what do you think Hume would have proposed as a method for the “magistrate” to keep the supply of money “ever increasing”? That sounds like government spending to me. Why doesn’t Scott Sumner go ahead and propose some of it?
Do you think Hume – who disliked banks altogether – would have been impressed with a policy of increasing bank reserves in a credit monetary system where those reserves consist only in easily manufactured electronic balances that are accommodatingly supplied by the government at almost zero cost whenever a banker extends credit?
Or I wonder if Hume has any passage in which he said, “The wise policy of the magistrate consists in keeping spending ever increasing by announcing to the subjects his conviction that spending shall ever increase.” I can’t think of one. That sounds more to me like one of the things he would have classified as “superstition” – in this case the popular attribution of occult powers to authority figures.
By the way, Hume never proposed anything like a hot potato effect. He argued that local increases in the supply of money caused more spending because until the money was spent out into the economy and prices had risen as a result, the new money had just as much purchasing power as an equal quantity of the existing money. So the people who receive the new money are thereby proportionally and temporarily richer, and richer people spend more than poorer people. His account was also based on the idea that labor doesn’t know what is going on, and so doesn’t demand higher wages.
What he rejected was the notion that there could be a shortage of money, since he thought that whatever quantity of money was in existence would “find its level” in the markets in which monetary commerce was already taking place. I don’t believe he ever argued that economic downturns were caused by anything that could be called a monetary disequilibrium, although he understood very well that they could be caused by the over-extension of credit and speculative bubbles.
johnny bakho: “What needs to change is not the inflation expectations, but the Demand expectations.”
You can interpret NGDP targeters as saying exactly the same thing. NGDP, by definition, =PtimesY Think of a particular value of P.Y as a rectangular hyperbola Aggregate Demand curve, with Y on the horizontal axis and P in the vertical axis. What we want to do is shift that expected future AD curve to the right, so that people will expect some mixture of higher future P and higher future Y. We don’t know what that mixture will be, because that depends on the slope of the Short Run Aggregate Supply curve, though we hope it’s mostly higher future Y. (If the SRAS curve is vertical, so that only P increases, then we are wrong, the Real Business Cycle economists are right, and increasing Aggregate Demand won’t do any good anyway.)
Plus, what dwb said. Keep rolling dwb!
W Peden: “As for giving money to the “poor”: what do you do when you want to cool down the economy? Take that money from the bottom 40%?”
Exactly. It is very easy to advocate a fiscal policy that increases AD. But unless someone who argues for a particular fiscal policy is willing to argue for the exact same policy in reverse when we need to reduce AD, you know they are just “One-way Keynesians”, and using AD arguments insincerely to hide some other agenda.
Similarly, some people argue we should halve debts to increase AD. I haven’t heard any of them say we should double debts when we want to reduce AD.
Well MMTers quite explicitly make clear that taxes should be used to regulate AD. And you frame the question in a loaded manner. The point is that you wouldn’t want to tax so aggressively that you send the economy back into a recession or depression. The goal would still be full employment.
wh10,
As Nick Rowe says, notice the implicit agenda here: raise public spending to increase AD; raise taxes to reduce AD. Such a programme is inevitably more political than a monetary stimulus, where you raise and reduce AD symmetrically and the incidence falls on the same group of people.
If you want to argue the case for bigger government and higher taxation, then a non-cyclical case has to be made. If I was cynical, I would say that the lasting popularity of the liquidity trap (in all its myriad forms) is it allows the case for “tax and spend” to be put in terms of unemployment vs. employment, which is a much more powerful argument than standard egalitarian rhetoric. However, I think that this is a case where correlation doesn’t equal causation: there is a common factor behind the fact that those sceptical of marketry and devoted to the idea of the power of fiscal policy are also usually very credulous of the ability of government spending to solve all sorts of other problems; and vice versa in the case of supporters of monetary policy.
Which is why I’m dubious of the use of terms like “idealogue” and “dogmatist” in monetary policy vs. fiscal policy debates: BOTH sides have prior moral and epistemological committments. Economics is useful because, while we’re all entitled to our opinions, we’re not entitled to our own facts and reality is a constraint on both sides, so we need to find out how economies work.
Nick Rowe,
When you agree with me, you agree with yourself: I learned that point from you, on this blog. Frankly, I like the idea of just sending round cheques to every adult- a negative poll tax, if you will. However, I don’t like the idea of a positive poll tax or asymmetric AD policy.
That said, if there was some special reason why OMOs and monetary policy generally was unavailable/impossible, then there could still be symmetrical fiscal policy via funding policy changes: either underfund public sector borrowing or switch borrowing from the non-bank sector to the banking sector. Both will increase the quantity of broad money.
The SRAS is positively sloped when businesses react to rising prices by hiring an additional unit of labor. They do so, in turn, when they feel that additional unit will be profitable.
How does the above fit with recent experience? We have the highest (at peak, actually) NIPA profits to GDP we’ve ever experienced in a recovery, yet employment growth is lackluster. Is the marginal profit from an additional labor hire dramatically lower than the average? Unlikely. Perhaps the cost of capital for the investment needed to produce that new hire is prohibitive? No, the real corporate WACC is quite normal right now and corporate bond issuance has been booming. Yes, small businesses are another matter entirely, which implies NIPA (domestic) profits are unevenly distributed like never before. Is this uneven profits distribution an AD issue or a structural one?
Given this large firm dominance, is there perhaps a higher degree of oligopolistic competition than in previous recoveries? There are signs that new-firm entry is constrained by the reduced intensity of financial intermediation. Arguably this is a supply-side problem. For instance, the “failed technology” of home equity withdrawal has removed a key source of start-up capital.
Maybe businesses in aggregate are profitable but don’t think they will find a buyer for that marginal unit of production? Except we have expected RGDP growth of around 2%-2.5%. NGDP growth expectations are about 4-4.5%. This is not an indication of abnormal demand uncertainty on the part of businesses.
In short, businesses expect growth, margins are at peak, and the WACC is normal. Why haven’t we seen less slope to the SRAS curve?
I don’t really understand why a recession is described as due to “en excess demand for money”. It seems rather the case that when the demand for money increases then unless suppliers lower their prices the number of transactions (and hence the level of economic activity) will diminish.
I’m also unclear why expectations matter so much. If the CB commits to stabilizing the price of money by adjusting the supply to match changes in demand then recessions should be avoided. It may perhaps be the case that this commitment will itself stabilize the demand for money but this seems more like an interesting side-observation rather than in any way key to the way that monetary policy should work.
Well, I didn’t feel like I needed to trot out and explain the darn TC rule again. It’s not like people here don’t know me, or are unfamiliar with my proposed fiscal spending rule.
The TC rule is a fiscal policy rule which gives a suggested level of deficit spending (manifested through payroll taxes) for levels of unemployment, inflation, and population growth. The population growth is to account for per captia growth, which just gets swept away by most people.
But my particular rule isn’t really the point here – it’s the fact fiscal rules exist and have been proposed by far more prominent people than me. And at this point, to remain a credible person, one needs to recognize monetary policy has huge problems. So does fiscal. Get over it.
I’d point out beowulf also has a good fiscal spending rule, and Peter Orszag has a nice rule. I’m sure many people could come up with fiscal rules. By aiming them at payroll taxes, it’s only 7% of someones paycheck. Heck, you could even mandate employeers show the payroll number to people every week so they aren’t shocked at a lower paycheck when good times come around again.
And frankly my rule doesn’t address the non-democratic Central Banks deciding it doesn’t like growth and contracting credit when circumstances allow them to have some impact on credit creation, or having them ignore the law about employment and inflation. The target unemployment rate is 4% by law. Unemployment trumps inflation concerns, again by law.
http://monetaryrealism.com/mike-talks-romney-listens/#comment-6429
Then in terms of “debt”, there I don’t think people who want to reduce the overall level of indebtedness believe somehow this always and everywhere translates into a 1:1 correspondence with AD. Steve Waldman thinks we probably have too much debt, and reducing the level of private debt would be a “good thing.” In todays particular situation, the level of indebtedness constipates monetary policy.
W Peden: Yep, if for some weird reason it were simply impossible for the central bank to buy and sell assets, then using helicopter money to increase AD and vacuum cleaner money to reduce AD would be the next best policy. Nasty when you need to go into reverse and use the vacuum cleaner, is the only problem. Or, as an intermediate case, if the only assets were physical assets like bridges, then have the central bank buy and sell bridges. If people want to say that’s fiscal policy, then go ahead (where is the exact dividing line anyway, if say, it buys and sells shares in bridges, or bonds issued by bridge-owners). But recognise that the stock of money stays higher even after the central bank stops buying bridges.
Exactly. It is very easy to advocate a fiscal policy that increases AD. But unless someone who argues for a particular fiscal policy is willing to argue for the exact same policy in reverse when we need to reduce AD, you know they are just “One-way Keynesians”, and using AD arguments insincerely to hide some other agenda.
I think this is a strange outlook Nick. Why in the world would someone want to advocate the exact same policy in reverse? If a field doesn’t have enough crops growing, you sow some seeds and water the field. If the plants then start growing riotously and are chocking each other off, you don’t go around removing seeds and water from the ground. Instead you mow, uproot or burn some of the excess growth.
From fact that the best way to develop and grow an economy might be to spend money among some population X doesn’t mean that that the best way to tamp down the economy if it is growing too fast is to extract money from the very same population.
I’m still thinking about Max’s good question.
Suppose there were a bit of paper, which gave the owner:
1. The (exclusive) right to live in a particular house for one day,
2. The right to sell that bit of paper to whomever,
3. The right to exchange that bit of paper for a second bit of paper dated the next day.
ownership of that bit of paper constitutes ownership of that particular house. The bit of paper looks like a one-day asset, but given 3 it lasts as long as the house.
On using fiscal policy to stabilize AD.
Why not just have a tax/subsidy on all final sales. Its a subsidy when AD is below target and a tax when its above. The further away from target the bigger the % of the tax/subsidy.
If expectations are really key then the tax/subsidy would always be neutral anyway.
Totally lost you as usual Peden, and as usual, you twist and read my words with inaccurate, loaded assumptions.
Nick said:
“But unless someone who argues for a particular fiscal policy is willing to argue for the exact same policy in reverse when we need to reduce AD, you know they are just “One-way Keynesians”, and using AD arguments insincerely to hide some other agenda.”
I arrived and said I will argue for the same policy in reverse – for the exact purposes of trying to prove I am not insincerely trying to hide some other agenda.
And I never argued for big govt and high taxes, so I am not sure where you got that. AD could be spurred with low taxes, too, and AD could be reduced through smaller govt too. The general goals I have in mind are full employment and price stability.
Dan: assume that total amount of water on your crops at time t is M(t)+V(t), where V is from rainfall and M is from irrigation. Let the optimum amount of water be A. Then optimum irrigation is given by M(t)=A-V(t). You need a countercyclical irrigation policy, in which irrigation is higher than normal when rainfall is lower than normal, and lower than normal when rainfall is higher than normal.
On Max’s question,
An overnight loan doesn’t mean that what is loaned has a value that lasts only overnight. Suppose A gives B a $50 bill on the condition that tomorrow B must give A a $50 bill plus a 1$ bill. As a result of earlier agreements and obligations, B then gives that $50 bill to C, and also receives from D another $50 bill plus two $1 bills. B then gives A the promised $50 bill and $1 bill. After our transaction is completed, the $50 bill in the hands of C, the $50 bill in the hands of A, the $1 bill in the hands of B and the $1 bill in the hands of A, still have the value they had before.
For a brief time, A also possessed a different asset, and B also possessed a different liability – the promissory note from B. When B then gives A the $51 dollars, that credit asset/liability is extinguished. B loses the credit liability, but in exchange loses the $51 cash asset; A loses the credit asset, but in exchange gains the $51 dollar cash asset. The IOU only had an overnight life; but the assets that the IOU was an IOU for have a much longer life.
Ron: that would work (if it’s money-financed), except: a VAT also has microeconomic consequences. It causes a deadweight loss (roughly) proportional to the square of the tax rate, so that having a varying tax rate causes higher average deadweight costs than having a constant tax rate that collects the same average revenue. Also, it has distributional consequences too, that may or may not be desired.
This is part of a general rule: fiscal policy has lots of microeconomic objectives too. If fiscal policy is doing those micro jobs well, it can’t also do the macro jobs well. Fiscal policy levers can’t be in two different places at the same time.
wh10: “I arrived and said I will argue for the same policy in reverse – for the exact purposes of trying to prove I am not insincerely trying to hide some other agenda.”
OK. I believe you.
In which case you have a genuine belief in a truly countercyclical fiscal policy. But now see my reply above to Ron Ronson.