Bill Woolsey has a very good post, written in response to my previous post. In this post I steal Bill's thought-experiment, but change "corporate bonds" into "land".
There is an alternate universe, just like our own, with one exception. For historical reasons*, central banks do not own government bonds. They own land instead. They buy and sell land, and adjust their target price of land several times a year, to try to keep CPI inflation at the 2% target. If a central bank fears that inflation will fall below the 2% target, it buys land and raises the target price of land. If a central bank fears that inflation will rise above the 2% target, it sells land and lowers the target price of land. Sensible economists build macroeconomic models where central banks set the price of land, because that is what central banks really do.
The simplest macroeconomic models in that alternate universe are long run models. They say that if the central bank doubles the target price of land, that will eventually cause the general price level to double too, other things equal. This is known as "land price neutrality". And they say that if the central bank makes the target price of land grow at 10% per year, that will eventually cause the general inflation rate to increase to 10% per year too, other things equal. This is known as "land price superneutrality". More sophisticated macroeconomic models incorporate sticky prices and expectations, and try to say something more precise than "eventually". Those more sophisticated DSGE models also introduce other shocks, and try to say something more precise about what central banks need to do when other things are not equal.
Macroeconomists in that alternate universe argue about the monetary policy transmission mechanism. The mainstream view is all assets are substitutes, to a greater or lesser extent. If a central bank raises land prices, that raises asset prices across the economy, which makes investment in newly-produced capital goods relatively more profitable, which increases aggregate demand. An increase in land prices, and other asset prices, also increases consumption demand, via wealth effects and substitution effects. Some economists stress the role of expectations, because if the central bank raises land prices people know that all prices must rise in the new equilibrium. A few Monetarists try to insist that what is important is that the central bank is issuing more money, and the rise in the price of land is just a symptom, rather than a cause. But nobody takes them very seriously, because everybody knows that real world central banks set the price of land, and the quantity of money is endogenous.
There is a bunch of monetary cranks in that alternate universe, who call themselves "New Keynesians". The New Keynesians want central banks to hold short-term Treasury bills instead of land, and target a short-term nominal interest rate instead of land prices, adjusting that nominal interest rate target several times a year to keep CPI inflation at the 2% target. They build macroeconomic models to show how central banks could target inflation by lowering nominal interest rates when inflation looks like it will fall below target, and raising nominal interest rates when inflation looks like it will rise above target.
Orthodox central bankers don't pay much attention to the New Keynesians. They are amusing thinkers, who come up with strange but interesting thought-experiments, but that is not how monetary policy works in the real world. Because real world central banks buy and sell land, not Treasury bills. And real world central banks set land prices, not nominal interest rates.
One day, the nominal interest rate on short-term Treasury bills falls to 0%. The orthodox central bankers gently tease the New Keynesians: "So, it seems your model has hit some sort of Zero Lower Bound! You can't buy buy short-term Treasury bills to lower their nominal interest rates below 0%, because people would just hold currency instead!"
This is the end of the road for the New Keynesians. They try to save their model by introducing something they call "forward guidance" on nominal interest rates, though nobody else can figure out how it is supposed to work.
But orthodox central banking carries on just as before. The price of land is finite, so when central banks want to loosen monetary policy they simply raise the target price of land, just like before. Orthodox central bankers simply cannot understand the concept of a "liquidity trap". So what if currency and short-term Treasury bills are perfect substitutes in some circumstances? It has no implications for monetary policy. The price of land is what really matters.
[*I have tried, and failed, to cook up some vaguely plausible alternate history of how central banks came to own land rather than government bonds. John Law was clearly involved somehow.]
Worthwhile Canadian Initiative 
JKH said: “For non-convertible currencies, MOA is the monetary base, because there is no other objection of conversion? It seems like a default in that case.”
I assumed no banks. Let’s sort of add banks. If demand deposits are not guaranteed 1 to 1 convertible, I’m not sure how that would work.
However, I believe your idea is right. Assume MOA (and MOE) is currency. Nothing is fixed/pegged to currency. MOA is currency only.
Squeeky Wheel, what do you think of all of this?
http://globaleconomicanalysis.blogspot.com/2014/01/singapore-set-for-icelandic-style.html
And, this in particular:
“Why Singapore Has A Dangerous Credit Bubble
Like many countries that have experienced economy-wide bubbles and busts – including the U.S. from 2003 to 2007 – Singapore currently has a ballooning credit bubble that is helping to drive economic growth and create an illusion of prosperity. Ultra-low interest rates are the primary reason why credit bubbles inflate in the first place, and Singapore’s bubble is no exception to this pattern.
An idiosyncrasy of Singapore’s interest rate policy makes their low interest rate-fueled credit bubble particularly acute: Singapore’s benchmark interest rate, known as the Singapore interbank offered rate or SIBOR, is tied to the U.S. Fed Funds Rate for the purpose of minimizing large swings in the U.S. dollar-Singapore dollar exchange rate.
Unfortunately, there are extremely dangerous side-effects of Singapore’s interest rate policy ever since the U.S. Federal Reserve has pursued its zero interest rate policy, or ZIRP, after the financial crisis in 2008. Near zero interest rates, which are intended to boost depressed economies like the U.S.’, are much too low for fast-growing economies like Singapore’s.”
Max said: “The MOA would remain a price index”
Nick at http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/10/medium-of-account-vs-medium-of-exchange.html said:
“it is the medium of account (all prices are quoted in terms of money); it is the medium of exchange (all other goods are only bought or sold for money)”
I agree with Nick here.
I don’t see how MOA could be a price index.
JKH or anyone else:
http://www.themoneyillusion.com/?p=20207 Scott Sumner’s blog
Money and inflation, Pt. 2 (Why does fiat money have value?)
“The previous post described the long phase-out of the gold standard. During the commodity money era we developed a dual medium of account (MOA), both gold and cash were MOAs. For there to be two media of account, the price of one in terms of the other must be fixed. Once gold prices started rising in 1968, only currency remained a medium of account; gold became a mere commodity. (Silver was demonetized in the 1800s.)”
He then goes on to focus exclusively on currency. Why can’t he see that demand deposits are almost always fixed/pegged 1 to 1 with currency?
Too Much Fed,
“Unfortunately, there are extremely dangerous side-effects of Singapore’s interest rate policy ever since the U.S. Federal Reserve has pursued its zero interest rate policy, or ZIRP, after the financial crisis in 2008. Near zero interest rates, which are intended to boost depressed economies like the U.S.’, are much too low for fast-growing economies like Singapore’s.”
See
http://en.wikipedia.org/wiki/Impossible_Trinity
Three possibilities:
1. Fixed Exchange Rate and Free Capital Flow
2. Independent Monetary Policy and Free Capital Flow
3. Fixed Exchange Rate and Independent Monetary Policy
Singapore has chosen option #1. The author implies that Singapore should choose option #2 or #3 – either a floating exchange rate or instituting capital controls – which would he / she prefer and why?
Frank Restly, not sure.
My earlier reply got lost to a grumpy network
JKH – Singapore is not a traditional currency board (ala Hong Kong or Brunei, which pegs to SGD). Singapore has a ‘managed floating exchange rate’. MAS targets a rate of appreciation against a basket of currencies (supposedly trade-weighted). MAS sets the rate of appreciation, a width of the allowed band – usually a few percent – and a center to that band. Monetary policy becomes a matter of changing the rate, width of band and occasionally recentering the band. Thus domestic interest rates are set by the Fed plus expected change in exchange rate.
Squeeky W.,
Thx
I think you may have explained this to me before.
My original point was that in almost all cases (‘now’ including this one) the CB still has to set the policy rate for bank reserves – through direct pricing parameters (i.e. rate bands) and/or through the control of the quantity of reserves and the effect of that control on the pricing of reserves – and that this is so regardless of what variables are considered in determining the target policy rate for bank reserves (e.g. variables such as land, CPI, FX).
JKH & Squeeky Wheel, what happens if the policy rate is set at 1% and land is expected to go up in price by 5% per year?
Asset bubble with currency denominated debt?
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