Scott Sumner and Bill Woolsey have been fighting valiantly against the Austrians. The fight is about "Cantillon effects" — non-neutralities of money that are supposed to arise not from the increase in the money supply itself but from where exactly that new money enters the economy.
Sometimes you get a clearer answer to a question if you change the question. That's what I'm going to do here.
Let's stop asking whether the effect of a change in the level of the money supply depends on where that new stock of money enters the economy. Instead, let's assume the money supply is growing at a constant rate, and ask whether it matters where that constant flow of new money enters the economy. We are simply redirecting that constant flow of new money, not changing the stock and redirecting it at the same time. It's easier to keep our heads straight that way.
Suppose there is zero real growth, base money is 10% of Nominal GDP, and base money is growing at 10% per year. So there's a steady 10% annual inflation, and a steady flow of new money equal to 1% of GDP.
1% of GDP isn't peanuts. But it's not very big either. And I've stacked my assumptions to make it bigger than it would be in most normal economies. If NGDP is growing at 5% per year, and base money is 5% of NGDP, the flow of new money would be 0.25% of NGDP.
I will assume the government owns the central bank. Any profit the central bank gets from printing money is government revenue. We can consolidate the government's and central bank's balance sheets, so any interest the government pays on bonds owned by the central bank is a wash. The government is paying that interest to itself. The central bank earns profits of 1% of GDP, and gives those profits to the government, which decides how to spend them.
Let's compare 5 different ways the same flow of new money could enter the economy.
1. Interest on money. The baseline scenario is that all new money is paid as interest on existing money. So every year people earn 10% interest on their money, which exactly offsets the 10% depreciation through inflation. It's a wash. It's really just like a stock-split.
2. Helicopter money. Scenario 2 is that all new money is paid as transfers to the population. It's no different from scenario 1, except that the opportunity cost of holding base money is higher (because it depreciates through inflation but doesn't pay interest), so the real stock of money would be smaller. (Plus some individuals might get lucky and others unlucky depending on whether the helicopter does or does not fly over them.)
2a. Cut taxes. The government uses the new money to cut taxes. Same as scenario 2. A tax is a negative transfer payment. So a tax cut is a transfer increase.
3. Debt reduction. Scenario 3 is that all new money is handed over to the government, which uses it to retire government bonds. Scenario 3 is the same as an open market purchase of bonds by the central bank. Scenario 3 is identical to scenario 2, plus a tax of 1% of GDP used to pay down the debt. Does it matter if the government increases taxes to pay down debt?
4. Government spending. Scenario 4 is that all new money is handed over to the government, which uses it to buy goods. Scenario 4 is identical to scenario 2, plus a tax of 1% of GDP used to buy goods. Does it matter if the government increases taxes and spending? Obviously it matters whether the government buys bridges or schools or roads or whatever. One gives us more bridges and the other gives us more schools, or roads, or whatever.
5. Other financial assets. Scenario 5 is that all new money is used to buy some other financial asset, like shares in IBM. Since the government owns the central bank, it doesn't matter if it is the government or the central bank that buys the IBM shares. Scenario 5 is identical to scenario 2, plus a tax used to buy IBM shares. Scenario 5 is also identical to scenario 3, plus a bond-financed purchase of IBM shares. Does a bond-financed purchase of IBM shares matter? I expect it depends on how close substitutes the two assets are in people's portfolios.
Sorry. What was the question again? Was it: "Do Cantillon effects matter?" Or was it "Does fiscal policy matter?" I can't tell the difference. There is no difference. "Cantillon effects" are just another name for "the effects of fiscal policy".
OK. I suppose that Austrian economists believe that fiscal policy matters. I suppose it does. And monetary policy has fiscal implications, because a faster growth rate of the money supply will mean bigger seigniorage profits for the government (as long as we stay on the left side of the Laffer Curve).
But the size of those fiscal implications depends on the ratio of the monetary base to nominal GDP.
In Canada, non-interest paying currency is currently around 4% of nominal GDP. An increase in the inflation target from the current 2% to 12% would mean a 10 ppt increase in the growth rate of the money supply. That would be a very big change in monetary policy. Even if the currency/NGDP ratio stayed the same at 4% (it would fall), the fiscal implications of that very big monetary policy change would be 0.4% of GDP.
What do you think would be the bigger deal: increasing the inflation target from 2% to 12%, or changing taxes or government spending by 0.4% of GDP?
[Update: hoisted from comments. J. V. Dubois says:
"You guys really do not get the gist of what Nick is saying?
1. Seigniorage of government controlled money IS TAX on base money
2. "Where" and how much of newly printed money is injected – even if that has any effect on redistribution IS FISCAL POLICY.
If you say that it makes a great deal of difference (deforming long-term
capital structure etc) if money is injected into salaries of government
employees vs purchase of bonds, then you by the same argument think
that it makes a great deal of difference if government decides that from
now on it spends 0.25% of GDP gathered in taxes on one versus another.
If you for instance say that Bond Dealers gather undue profits from
these bond operations of the size of 0.25% GDP – then by the same
account you have to be outraged that those very same bond dealers gather
undue profits from regular yearly government deficits an order of
magnitude higher. It is a problem of interest group capturing government
and preventing competition from access to the bond market, it is not a
problem of money printing."]
Worthwhile Canadian Initiative 
The only Cantillon Effects that much interests Hayek are those that change the stock of shadow monies/money substitutes and lengthen the structure of production in an non-sustainable fashion.
It’s really essential to get this effect to assume an ever increasing percentage rise in the domain of money, credit and shadow monies/money substitutes.
At least if you are engaging the guy who did the work to build the ‘Austrian’ picture of this.
“We are simply redirecting that constant flow of new money,”
OK.
Randomly, and with no notice of any kind, on day 1 we redirect that money into the purchase of Mortgage Backed Securities.
Randomly and with no notice of any kind on day 2,000 we cut of that flow of money and redirect that money into the purchase of back rubs.
The point of the exercise, I assume, is to illustrate a systematic structural dis-coordination across the time and production and price structure of the economy, including the interest rate price.
What do you think?
Think we have a wrenching disconnect in the time structure of production here?
If not, why not.
Greg: suppose we increased taxes, and used it to buy MBS, or backrubs. Would that also create a wrenching disconnect in the time structure of production?
This “where” business is just short language for forced savings allowing for longer production processes promising superior output induced by an interest rate which has fallen below the interest rate possible via the sustainable savings rate.
Ie its snowballing endogeneous money in the banking system & shadow money credit backing investment in long term production goods like houses.
The “where” is the houses, the financial system. Yes, the Fed can have a role, even a primary role. But the same process is possible without a central bank, or can be do to “money from China”, etc.
Nick writes,
“The fight is about “Cantillon effects” — non-neutralities of money that are supposed to arise not from the increase in the money supply itself but from where exactly that new money enters the economy.”
Here’s a Google NGRAM of ‘neutral money’ and “forced savings’.
You’ll see them explode in the English literature at the same time, at the time of Hayek’s famous 1931 LSE lectures published as Prices and Production:
http://books.google.com/ngrams/graph?content=neutral+money%2C+forced+savings&year_start=1800&year_end=2000&corpus=15&smoothing=1&share=
Non-neutral money and forced savings were linked concepts at the time.
If I remember right, it’s Hayek also who goes through the history of economic thought of all this for the English economists for the first time, going through Hume and Cantillon etc on neutral money and Cantillon Effects and Bentham and others on forced savings.
Here’s an NGRAM for ‘neutral money and ‘Cantillon’. You see that same 1931 explosion:
http://books.google.com/ngrams/graph?content=neutral+money%2Ccantillon+effects&year_start=1800&year_end=2000&corpus=15&smoothing=1&share=
Hayek introduced Cantillon and Cantillon Effects in order to open the door for English economists to think about interest rate and money and credit induced extensions of more lengthy production processes promising superior output — the Bohm-Bawerk stuff assumed in Wicksell that British economists didn’t know anything about.
Nick writes,
“Greg: suppose we increased taxes, and used it to buy MBS, or backrubs. Would that also create a wrenching disconnect in the time structure of production?”
The question is, how wouldn’t it?
Lets go to a more stark thought experiment.
In case #1 we use all of our income (except what is required to eat carrots) to create ever more complex and massive computerized and mechanized fish farms.
In case #2 we used all of our income (except what is required to eat carrots) to pay individuals to catch fish by hand.
Imagine by fiat that we switched from case #1 to case #2.
Basically, all of the capital goods used to produce the production goods required to make the fish farms would lose their economic goods status.
All of the worker would be skilled in all of various tasks required to create the production goods for the fish farms, but wouldn’t know how to fish with their hands.
Anything case #1 good potentially salvageable that might help a guy fishing with his hands would have to be converted for that use, requiring labor and perhaps the creation of other, new production goods.
We can imagine that the production goods eventually supporting fishing with your hands might develop in sophistication over time, but that would take time.
So…Sheldon Richman was right, and Scott Sumner should apologize? I don’t get the sense that’s what you’re trying to say, Nick.
It’s as if Jesse Jackson says, “It matters whether the police shoot at a fleeing bank robber vs. an innocent teenager!”
Then the NYPD chief says, “No it really really really doesn’t matter.”
People flip out, and then the NYPD chief (and his Canadian lawyer) elaborate, “Oh, we were assuming we were talking about scenarios in which the bullets all miss their targets. When they actually hit, we don’t classify that as ‘shooting,’ we classify that as ‘hitting.’ You whiners need to use standardized nomenclature before you complain next time.”
Dear Greg, unlike e-mail and like most prose, in most parts of the Internet it is conventional to put the quoted passage before the text you are replying to. Also, you may find the <blockquote></blockquote> tags useful, both on here and on Sumner’s blog.
I mean, you do write and quote liberally, no offense.
Ah… before the text to you are writing as a reply. Brain fart.
Nick writes,
“Greg: suppose we increased taxes, and used it to buy MBS, or backrubs. Would that also create a wrenching disconnect in the time structure of production?”
Didn’t the Soviet Union already run this experiment?
This is one reason some people supported the Soviet model — the state could accelerate growth & wealth via direct forced savings, ie redirecting resources into lengthier production processes promising superior output — for example giant steel mills & imported 40 year Scotch for Stalin — rather than into shorter production process goods inferior output — neighborhood iron black smiths, cut flowers, back rubs, and vodka.
And when the forces savings regime came to an end — wrenching disconnect in the structure of production.
One more on this.
Nick writes,
“Greg: suppose we increased taxes, and used it to buy MBS, or backrubs. Would that also create a wrenching disconnect in the time structure of production?”
In the US we in part ran this experiment in housing over the last decade, via all sort of unsustainable and effectively yo-yoing government policies helping to direct resources into the long term production good of housing.
The big issue is when you make changes that turn highly productive long period production goods into non-economic goods or into production goods re-purposed in processes producing far less income and value or into goods that perhaps can be used, once someone discovers or invents a use for them.
Consider the hundreds of miles of moth balled lumber rail cars parked across the United States in the wake of the construction crash.
Arnold Kling make a similar point about specialized labor.
When you suddenly cut off various streams of every longer production processes, the effect is different than when you gradually add to streams of gradually lengthening production processes.
The former and not the later suddenly throws production goods into non-economic goods status.
Nick,
I’d argue that 1 is actually contractionary because the nominal short rate will have to go to 10% (otherwise people wod borrow and hold currency).
2 is quite different because it principally constitutes a wealth transfer from creditors to debtors. Since debtors tend to be credit constrained, this is strongly stimulative.
4 is similar to 2. The money gets spent.
3 and 5 do nothing (Wallace irrelevance)
people would borrow…
Examples of long term production goods becoming non-economics goods — VIDEO of nearly completed homes being bulldozed in Southern California in 2009:
http://abclocal.go.com/kabc/story?section=news/local/inland_empire&id=6797624
http://www.nbclosangeles.com/the-scene/real-estate/Developers_Bulldoze_Empty_Luxury_Homes_in_Victorville_Los_Angeles.html
Here is a photo of some of those mothballed lumber rail cars in North America:
http://archive.mises.org/13572/seeing-is-believing-20-miles-of-empty-and-mothballed-lumber-hauling-rail-cars/
I personally drove past 20 miles of them in 2010.
How would you analyze the FDR gold devaluation, or a modern day exchange rate intervention? Surely they aren’t neutral, since prices don’t automatically and uniformly increase in response.
Nick
This is a fair typolocy, however, the question remains – do you agree with Scott’s definition of ‘holding fiscal policy constant’?
If you do, then I suppose, when a typical central banker talks of easing monetary policy through govt. bond purchases, what he’s really doing is easing monetary policy + tightening fiscal policy?
Corollary is, that the only ‘true’ monetary policy, one where fiscal policy is held ‘constant’ is a helicopter drop. Or, all money is helicopter money.
Is the above a fair parsing?
Nick:
Excellent post.
I think the core Austrian view is that an excess supply of money causes the market interest rate to fall below the natural interest rate, and that the lower market interest rate impacts the allocation of resources similar to a lower natural interest rate due to an increase in the supply of saving.
When one begins to challenge these arguments (which I think are qualitatively correct,) many of the responses imply that the equilibrium effects you describe are being balled up with the disequilibirum process.
This would be most blantant with the AAN group (Amateur Austrians of the Net.) For example, if the inflation doesn’t lead to malinvestment, then it must be that counterfeiters gain nothing. Well, counterfeiters gain something, and pretty much everything even when there is no disequilibrium.
If the government is the “counterfeiter” and so we characterize the gain as a type of tax revenue (seignorage) then this does come down to “fiscal policy” in the broadest since, as you suggest. Though I think that perhaps “public finance” is a better way to look at it, since “fiscal policy” is often used to mean something more narrow–changing taxes or government spending, the budnget deficit, and so aggregate demand.
Nick,
Scott Sumner never addressed this question I raised on his blog – perhaps you’d like to take a crack at it…
Assuming a Sumnerian world, why do banks consent to transactions with the Central Bank? What’s it in it for them? I think I am at the point where I understand what Sumner is suggesting about the macroeconomy, but if he is correct then it would seem to suggest to me that banks have no good incentive to deal with the Central Bank at all.
You guys really do not get the gist of what Nick is saying?
1. Seigniorage of government controlled money IS TAX on base money
2. “Where” and how much of newly printed money is injected – even if that has any effect on redistribution IS FISCAL POLICY.
If you say that it makes a great deal of difference (deforming long-term capital structure etc) if money is injected into salaries of government employees vs purchase of bonds, then you by the same argument think that it makes a great deal of difference if government decides that from now on it spends 0.25% of GDP gathered in taxes on one versus another.
If you for instance say that Bond Dealers gather undue profits from these bond operations of the size of 0.25% GDP – then by the same account you have to be outraged that those very same bond dealers gather undue profits from regular yearly government deficits an order of magnitude higher. It is a problem of interest group capturing government and preventing competition from access to the bond market, it is not a problem of money printing.
RPLong:
If I offer a bank a $100 bill in return for $100 worth of bonds, why wouldn’t they agree to the trade? Especially if I threw in a few extra cents of commission?
Bob: In all except maybe scenario 5 (where the government sells bonds to purchase IBM shares) I am using an absolutely standard definition of fiscal policy. Changing G and/or T. But 5 is just the government buying shares on margin, which is something that a lot of people do every day.
Why does fiscal policy, or somebody buying IBM shares on margin, cause a total discombobulation in the Hayekian time structure of production?
And if it does cause a discombobulation in the time structure of production, why aren’t Austrians yelling about that every time the government changes G or T by 0.4% of GDP? Or somebody buys IBM shares on margin?
Man, but you Austrian guys must think the market economy is an awfully fragile flower.
Nick, I of course agree that fiscal differences matter. I was discussing the Austrian view that if the central bank buys injects money by buying bonds, it depends who they buy them from. But fiscal policy is the same whether the bonds are purchased from person A or person B. I assume you agree with that. Appearently some Austrians don’t.
Ah. I see that JV Dubois gets it, and has said it better than me.
Scott: we are very much on the same page, I think.
Bill: “Though I think that perhaps “public finance” is a better way to look at it, since “fiscal policy” is often used to mean something more narrow–changing taxes or government spending, the budnget deficit, and so aggregate demand.”
Yep. Good point. And thanks!
Nick,
I think Cantillion effects can be considered as follows:
Liquidity preference – The first injection of money can be considered to be by an agent that has a liquidity preference of 0 (all of the money is spent). As the money then propogates through the economy it encounters resistance (liquidity preference greater than 0) by each agent that it passes through.
“An increase in the inflation target from the current 2% to 12% would mean a 10 ppt increase in the growth rate of the money supply.”
Remember your discussion of cartels. The central bank is a cartel, but it cannot try to control two things at once. It can target the growth of money supply and let interest rates float or it can target the interest rate and let the growth of money supply float. An increase in the inflation target from 2% to 12% targets neither the interest rate nor the growth rate of the money supply. And so a central bank can create an inflation target, but it has no means of enforcing that target.
MV = PQ
It does not matter what the central bank does in terms of reserves, they could print a quadrillion dollars that never sees the light of day and would have no effect on the economy. Money begins as a debt and so we rewrite M as D.
DV = PQ
PQ is the nominal value of all goods that are purchased. They can be purchased out of unsaved current income or they can be purchased with new debt.
DV = I * (1 – LP) + dD/dt : Liqidity preference (LP)
Income (I) is the sum of interest payments made on debt and the sale of goods (PQ)
DV = ( INT * D + PQ )*( 1 – LP ) + dD/dt
PQ = DV
DV = ( INT * D + DV ) * ( 1 – LP ) + dD/dt
D = exp ( f(t) ) – f(t) is the demand for new money (debt)
dD/dt = f'(t) * exp( f(t) )
V * LP = INT * ( 1 – LP) + f'(t)
V = INT * ( 1 – LP ) / LP + f'(t) / LP
Plugging this expression for V back into our equation:
D * [ INT * ( 1 – LP ) / LP + f'(t) / LP ] = PQ
PQ can be re-expressed as Real GDP * ( 1 + Inflation Rate )
INT can be re-expressed as the Real Interest Rate + Inflation Rate
D * [ ( RINT + IR ) * ( 1 – LP ) / LP + f'(t) / LP ] = RGDP * ( 1 + IR )
[ ( RINT + IR ) * ( 1 – LP ) / LP + f'(t) / LP ] / ( 1 + IR ) = RGDP / D
Productivity can be expressed as Real GDP / Debt
[ ( RINT + IR ) * ( 1 – LP ) / LP + f'(t) / LP ] / ( 1 + IR ) = PROD
Solving for the rate of inflation:
IR * ( 1 – LP ) / LP – IR * PROD = PROD – f'(t) / LP – RINT * ( 1 – LP ) / LP
IR = [ LP * PROD – f'(t) – RINT * ( 1 – LP )] / [ 1 – LP – LP * PROD ]
And so the inflation rate is not strictly the growth rate in the money supply (credit supply). It is a function that is dependent on several variables. The inflation rate depends on:
Productivity (PROD)
Real Interest Rate (RINT)
Liquidity Preference (LP)
Credit Demand (f(t))
Nick, JVD
Let’s agree with what you’re saying.
So, the fiscal impact of an OMO is similar/analogous to the fiscal impact of raising taxes to pay out bondholders.
Ergo, an OMO = helicopter drop + transfer of seigniorage revenues to bondholders.
Agree/disagree?
Ritwik: disagree. Slightly.
OMO purchase of bonds = helicopter drop + tax increase to purchase bonds.
A tax increase to purchase bonds isn’t the same as a transfer payment to bondholders. The government is buying bonds from them, not giving them a transfer payment.
Max: sure. Prices are sticky. So changing the money supply has real effects. But that is true quite apart from Cantillon effects.
Nick,
It seems to me that everyone is confused! What I would agree with is that monetary policy (getting the real rate close to the natural rate) is the only efficient way to regulate the macroeconomy, and the differences between the different scenarios above relate to how they effect fiscal policy in addition to how they may or may not be implementing monetary policy.
The problem is that the model economy on which you’ve based your five examples bears no structural relation to a modern pure credit economy so the illustrative effect is totally lost on me. E.g. the first example doesn’t produce anything like 10% inflation in the economy. Lets say you suddenly start to pay 10% interest on currency. All short lending rates will immediately rise to 10%+ (by arbitrage). Inflation expectations will plummet as consumers attempt to hoard cash and preserve savings. Demand for new loans will drop, loan repayments will skyrocket and bank balance sheets will collapse as a result. The monetary base does not figure as a relevant variable in the explanation. If you wanted to do your experiment you’d have to convert to a purely electronic currency. But to achieve the inflation you are looking for you’d have to cut, not raise the rate you pay on the currency.
So while I kind of agree with your main point (I think), your examples would be more helpful/convincing if they were set in a framework that behaved more like the one we live in.
[Somewhat OT…]
One thing that rarely seems to be discussed is why the free market can’t get the real rate right all by itself. Why is there this one price in the market that the government has to set? (Austrians surely disagree?) It seems to me that the problem is that the monetary authority determines the nominal rate. And the dynamics of inflation expectations (Keynesian coordination problem) are such that they don’t move up and down in parallel with the nominal rate (in fact they move in the opposite direction) and therefore the monetary authority determines the real rate (which is tough because it’s like driving backwards with a trailer). Which, I guess, is why the CB should be setting NGDP futures and not rates (no trailer and driving forwards looking out the front window).
Then the question (to get somewhat back on topic) is whether setting NGDP futures would be more efficient (less “fiscal”) than setting rates. The answer is that whatever policy is likely to get the real rate closer to the natural rate is the most efficient. NGDP futures wins hands down.
Alex,
Good point. So then you must agree with me that the banks experience a direct and significant advantage to dealing with the central monetary authority. Could it be that these advantages – to which the financial sector has access, but the rest of us do not – are precisely what the “Austrians” are talking about?
K:
If money paid 10% interest and there is no RGDP growth, in the Long Run you really really do get 10% inflation. I think that is Nick’s claim.
Nick
So, you agree with Scott that CB bond purchases don’t affect bond prices?
RPLong:
No, because the advantage is really, really small compared to the scale of Fed activity (and invisible compared to the scale of the whole economy). You are talking about, what, a few tens of millions of dollars a year in what are basically administrative fees?
Nick, we already know the market is ‘fragile’ — the problem raising pattern is what starts the process of conceiving the processes and mechanisms which make the fact possible.
We can conceived perfect plan coordination in our head building an equilibrium construct.
What is the ‘loose joint’ which allows the system the flexibility which is already observed?
We are dealing with a complex system, and not with a two variable linear action, reaction relation between eg billiard balls.
So we go looking for what the philosopher of explanation Larry Wright calls ‘trace data’ — suggestive hints that play two roles. The help us conceive what the process is, and they later make up elements of the explanation of the original problem to be explained.
So what are some of the trace data?
Well, the big one is extra-ordinary fluctuations in monies, credit, interest rates, finance, shadow money, money substitute asset values, liquidity, etc.
See here:
http://hayekcenter.org/?p=2954
And it turns out we can identify how banking and finance tied in various ways to the rest of the economy can yo-yo price relations and the availability of means of exchange — money can be ‘endogenously’ created and vaporized within the financial sector, tied in important ways to flexibilities in the production and consumption economy, eg to expanding resources into longer production processes which take time to expose their profitability or loss making, or contracting these.
So we have complex process capable of providing the ‘loose joint’ required from the observed fragility of the economy.
Is that all there is to the fragility?
No.
We haven’t yet introduced central banks, or pathological financial regulations, or national currency laws, or insolvent nations, or international monetary economics, money contracts, or, well, you get the idea.
The ‘loose joint’ explanation is an ‘ultimate cause’, its at the core of a complex explanation.
But explaining the size and duration and scope and historical character of a fragility episode brings in all sorts of other proximate causes, eg Milton Friedman’s account the causal effects of the deflationary policies of the Fed, the role of the Smoot-Hawley tariff in crashing agricultural and the effect of that on crashing US banks banned from practicing national branch banking, expansions of unemployment insurance, fixed money contracts & other ‘sticky price’ barriers to system flexibility and future oriented expectational coordination.
Usually, economists misread Hayek’s seminal essays “Economics and Knowledge” and “The Use of Knowledge in Society”. They claim Hayek assumes Arrow’s picture of the ‘invisible hand’ — its magic instant coordination jumping right off the math of the GET. That’s not Hayek. Hayek’s whole lesson in those essays, learned from looking at the real world problem of coordinating production choice across time in the literature on central planning and business cycles — is that coordination is bottom up groping in the dark using only local knowledge and limited understanding of trace elements of the relation of networks of prices.
The market isn’t the magic of a GE construct and its isn’t a delicate flower — its a hard won marvel with a loose joint — a loose joint which often has monkey wrenches thrown it for good measure by folks who do not understand the complex process and how it has degrees of freedom that allow it to move here and there to some degree in directions that are unsustainable and that required period episodes of re-coordination.
The reason I’m talking about bond prices and a transfer of seigniorage is – you can think of the raised taxes to finance the bond purchases as being drawn against the seigniorage power of freshly issued money, and the govt reducing supply/ CB increasing demand (stock/flow/whatever) for govvies pushes up their price.
Do you disagree that there will be an increase in prices?
Scott argues that there’s no increase in the price, fiscal policy held ‘constant’. My contention was that he was using a funny definition of fiscal policy held constant.
Similarly, if the CB was to inject fresh money through govt employee salaries, it would be a transfer of seigniorage revenues (or, taxes, take your pick really) to government employees.
So, the only case of money injection that’s fiscally neutral is a helicopter drop.
Agree/disagree?
The other major ‘trace data’ we see in the problem raising pattern of ‘fragility’ we have in front of us I’ve already pointed to, the production goods were are bulldozed and mothballed, the 1/4 of all unemployed early in the US bust of the 2000s who were construction workers, etc.
Alex,
I agree that the macroeconomic impact of the benefits that we both agree exist is small when compared to the overall impact on the economy at large.
I disagree that this small impact “makes no difference.” If I can make money on the deal being offered, then it makes a difference to me. If the Fed or the Bank of Canada truly have the macroeconomy in mind, then shouldn’t they devise a new form of monetary policy that does not enable a certain segment of the population to make millions while the rest of us deal only with inflation, without the benefit of the millions in profits that come with having private access to the machinery of fiscal policy?
In short, if it “makes no difference,” then it is all the more unconscionable that only a few of us have access to these transactions. Wouldn’t you agree with Milton Friedman that a literal helicopter drop or a computerized interest rate adjustment would be superior?
RPLong, this is like complaining about the fat-cat toilet paper companies that stock the Fed’s bathrooms. If the Fed wants to buy a billion dollars worth of bonds it is impractical for them to go door-to-door asking individuals if they have any for sale.
K,
“And the dynamics of inflation expectations (Keynesian coordination problem) are such that they don’t move up and down in parallel with the nominal rate (in fact they move in the opposite direction) and therefore the monetary authority determines the real rate (which is tough because it’s like driving backwards with a trailer).”
The monetary authority is limited by the 0% lower bound for nominal interest rates. Meaning that during severe deflation, the real interest rate can keep rising even when the monetary authority has set nominal interest rates to 0%.
The monetary authority can only set nominal interest rates.
K
“Why is there this one price in the market that the government has to set?”
Various explanations exist.
1) If you think of this rate as the risk-free short rate, Geanakoplos et al have shown that a market GE doesn’t converge on the socially optimal numeraire, leaving government as the authority to set the rate on the financial numeraire (and tying that up with the consumption numeraire through a consistent price regime).
2) If you think of this rate as the risky cost of capital, one can take the Keynesian (circa Treatise of Money) view that financiers will set this too high purely as a matter of convention i.e. adaptive expectations make the LM curve horizontal-ish.
3) If you think of some combination of 1 and 2, or the risk premium, you can take the view that this is subject to socially sub-optimal volatility (ch12 Keynes). You can even take the Schumpeterian view that the risk premium is too high secularly through-out history and it’s only because of the bankers, the capitalists par excellence, that we’ve managed to make any progress. In this view, the government steps in to solve the market risk premium problem every time that the financial system refuses to.
4) You could take the Gesell/Keynes/Marx view that the short risk-free rate is in some sense reflective of the relative power of the moneyed interest and the non-moneyed masses, and hence (my interpretation)the morally correct risk free real rate is 0%, which the community/government imposes.
5) Through some combination of 1,2,3,4 you could argue that the government’s main commercial role is to act as an inter-temporal insurer that chooses the superior wealth equilibria in a sequence of choices between multiple equilibria, aided by the fact that it is unconstrained by the profit motive, has no liquidity constriant and a fairly flexible budget consraint. I’d imagine that this role could be shown to be isomorphic to setting the yield curve, or assuming efficient markets, the short rate.
There are big information and public choice issues, of course, as with any government activity. But the pure theory of public finance as exerting control on real interest rates is probably on rather solid grounds.
Alex Godofsky,
“If money paid 10% interest and there is no RGDP growth, in the Long Run you really really do get 10% inflation.”
I don’t agree. You are setting a permanent 10% nominal short rate. That is not a stable equilibrium, ever. So you will either be in debt-deflation or hyper-inflation. You may switch between them, especially from debt-deflation to inflation. And that’s just in a sensible model economy. Meanwhile, back in the real world, if you manage the currency like that it will be abandoned as money pretty quickly, so there wont be any Long Run for that currency.
K:
Yup, you’re right, I retract the earlier claim.
You market monetarists are something else, Nick. Scott writes a post titled “It really really really doesn’t matter…” (yes, three “really”s by him in the title), and now the burden of proof is on me to show that the economy would have a boom-bust cycle because of Cantillon effects?
Scott dodged this question when I asked, Nick, so please tell me your answer: In normal times (not when we’re up against ZLB), if the Fed decides to cut short-term interest rates and buys Treasuries, do you agree that this really does push down short-term interest rates (raise price of short-term safe bonds)? You can give whatever caveats you want, but I want to understand what power you think the central bank has over the market price of bonds, if any.
Alex, I would only agree with your analogy if buying toilet paper were the Fed’s preferred monetary policy instrument.
Think of it this way:
When the fed buys bonds from specific people, they receive two things: (1) all the same monetary policy affects we do, and (2) a direct profit that can be reinvested as a hedge against inflation, which they only receive because they do business with the Fed.
Me, on the other hand: I get (1) but I do not get (2).
Alex Godofsky,
You’re a noble man. I endeavor to be as magnanimous.
RPLong:
Yes, and when the Fed employs specific people, they receive two things: (1) …, and (2) a salary. But I don’t complain bitterly about how Ben Bernanke is getting rich off my tax dollars, and why can’t we ALL get salaries from the Fed, etc. The profit the banks make on the transaction is just the normal compensation any business receives for providing a service.