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 
“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.”
I don’t think these are precisely symmetrical. A modern bank doesn’t adjust the target price for bonds in order to keep inflation on target, it adjusts the target for the rental rate on reserves. If it did set government bond prices as its target, it would be in a different sort of universe than the one we’re in now. So you’re alternate universe is like our own, but with several exceptions. A land-owning central bank could also buy and sell land in a way to hit its target for the rental rate on reserves, in which case it would be exactly like a modern central bank, save for the one exception that it held land instead of government bonds.
JP, good points, but I didn’t completely follow your train of thought at the end. First you said Nick’s world was quite different (and I followed your logic), but then I read you as saying it wasn’t that much different (which I might agree with – see below).
If Nick had said the central bank’s operational target remains the interbank rate and all the CB changes is that they’ll conduct OMOs with land instead of govt bonds (and there’s no land price or bond price operational targeting to speak of), then his world would be quite similar. Indeed, the asset of choice for OMOs was not always government bonds. For example, government bonds didn’t become the OMO asset of choice in the U.S. until after WW2, when the financial system became flush with them. Before that, there were “real bills,” bills of exchange, etc.
But if we now say the CB is going to try to target the price of land AND the interbank rate through OMOs of land, that’d be like saying the CB will target the price of bonds and the interbank rate via OMOs of bonds. Well, I suppose both are possible. We’re sort of doing that today in the U.S., and the Fed did it before the U.S. Treasury Accord. By setting the right combo of a) floor and ceiling rates, b) reserve requirements, and c) the size of the land or bond OMO, the CB may be able to do both. So I suppose I agree with you, even though I’m not 100% following what you said :).
For Mike Sproul and JKH:
The way central banks are run now, they don’t refuse to take back currency for gov’t bonds? Right?
Nick Rowe: “Given that half the time the economy is going too slow, and the other half too fast, would you be happy to take money out of the hands of the poor whenever we need to slow it down?”
Weren’t you the one who let me know that skimming off the top is the least distortionary way? (One Big Union)
“It could always sell land short, basically borrowing against its future seigniorage profits.”
Future seigniorage profits are an asset of the Treasury, not the central bank. In the U.S., the CBO makes baseline budget projections that include seigniorage profits. Falling short of this baseline increases the projected deficit, which increases the taxpayers’ tax liability.
Nick, how would the land short sell work exactly? Also, I was going to say that if the Fed ran out of assets today, it could always sell its own bonds or offer its own time deposits. But that concept doesn’t translate directly to land, since the Fed can’t create land.
First I’m not economist so I apologize if my question seem both simple and dumb.
Is not land a limited resource ? What happen if
#1 There is no more land to buy for CB ?
#2 There is no more land to sell for CB ?
Will not those two case be identical in your alternate universe to a money ZLB in our ?
Second, I’m under impression that you set an erroneous link between ZLB and Liquidity Trap. For Keynes, a LT can occur at any CB interest rate but later is a mean to avert eventual LP effect. When ZLB is hit LP effect can not be more offset. It is LP => ZLB not the other way around.
ATR,
By standard, I meant something like this:
Click to access 0809keis.pdf
JP,
“In the gold standard days, a central bank like the BOE converted notes into gold and vice versa as well as setting its discount rate …
I don’t think these are precisely symmetrical. A modern bank doesn’t adjust the target price for bonds in order to keep inflation on target, it adjusts the target for the rental rate on reserves”
Right. They do both.
Even if today one makes the case that under QE the CB targets the quantity of bonds on its balance sheet without necessarily targeting the price of bonds directly or effectively, it has to do both asset and liability targeting.
The CB can transition from exclusive liability price targeting (conventional reserve management, with or without IOR, with various rate boundary management arrangements optional) to combined asset price targeting (gold/land/QE pricing) and liability price targeting (the price of reserves, one way or another).
But with asset price targeting, the CB must do both – i.e. it must continue to do separate but co-ordinated liability price targeting. The CB sets the policy rate. The market follows what it thinks the CB will do with the policy rate.
Nick,
I don’t think that simply saying “Would it make much difference…?” answers my point. So I’ll repeat my point.
Having the central bank purchase just one asset (land, government debt, or whatever) is distortionary. Strikes me that’s obvious from the effect of QE: QE has boosted the price of assets that are similar to government debt, i.e. shares. As to the effect on spending on Main Street, that’s been more muted. Plus spending by the US government on infrastructure during the crisis actually DECLINED: completely barmy. It should at the very least have remained constant, or preferably risen a bit.
And I’m not arguing for pure fiscal policy with no monetary element. The problem with fiscal alone is crowding out. Plus having the government / central bank machine borrow money when it can print the stuff strikes me as lunacy. I therefor favor the policy advocated by most MMTers and by Positive Money: simply create new money and spend it (and/or cut taxes) in a recession.
Min,
As you’ll see from my above answer to Nick, I pretty much agree with you. Though I don’t agree with SPECIFICALLY targeting the poor, any more than agree with specifically targeting government debt, or land (as per Nick’s suggestion).
“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”. ”
This paragraph is patently false in all but the most knife edge case. It is only true if the rate of productivity growth is identical for all goods traded all the time.
This would never be true, for example the rate of producitivity growth in services tends to be lower than in manufactures.
The conclusion of this post is simply wrong. It is not true that the central bank can control inflation, on any timescale, by controlling the price of a single traded good or asset unless that implies control of the real interest rate.
Adam P: It is simply the standard neutrality/superneutrality/quantity theory of money restated.
Sure, if the equilibrium (natural) real value of land is growing at 1% per year, then a 10% growth rate in the nominal price of land causes 9% inflation. That’s why i said “other things equal”. Or, we could restate it as: “a 1 percentage point increase in the growth rate of the price of land causes a 1 percentage point increase in the inflation rate.” Same difference.
“The conclusion of this post is simply wrong. It is not true that the central bank can control inflation, on any timescale, by controlling the price of a single traded good or asset unless that implies control of the real interest rate.”
The conclusion is totally right. Actually, it’s a lot easier to see how a central bank can control the price level by controlling the nominal price of land than it is to see how it could do it by controlling the nominal interest rate. Because you don’t get the Steve Williamson/Kocherlakota problem. It’s totally standard classical dichotomy, for the long run result. Real factors determine relative prices; so if the CB controls one nominal price that determines all nominal prices. Sure, nominal interest rates will change too, if the CB changes the growth rate of land prices. And real interest rates will change too, in the short run, if the CB changes the price of land and prices are sticky. The Price/rent ratio for land is (the reciprocal of) a (very long term) real interest rate.
ATR: “Nick, how would the land short sell work exactly?”
I confess I’m not exactly sure. Because land isn’t fungible (each acre is different). But I vaguely remember hearing there was some way to short houses, which also aren’t fungible)? But if you promise to pay a stream of payments, indexed to land rents, you have effectively created synthetic land.
ATR: “I think Nick’s point is that he doesn’t care where rates wind up, as long as he achieves his land price target. He thinks the land price target is enough for the CB to achieve its objectives.”
Yep.
TMF,
“The way central banks are run now, they don’t refuse to take back currency for gov’t bonds? Right?”
There’s no obligation for a CB to be on the offer for bonds. If they’re not in the market for other purposes, they’re just as likely to steer some lost customer to a bond dealer.
ATR,
Policy rates “wind up” where the CB sets them.
What I am really wondering about now: If the CB can just pass land to the government why can it not also pass on money and let the government buy the land? Where do you draw the line between monetary and fiscal policy?
I do not think their banks directly bought and sold land, but historically certain nations at times had land be the nominal base of their currencies. Probably the most famous case was the German rentenmark, although hyperinflation in the 1920s led to its demise, with this supposed land price anchor providing no stability in the end.
When you talk about buying land as a solution to the ZLB, you’re talking about the purchase as a trade (like Warren Buffet’s financial crisis investments), not as a means of permanently shifting the price level, correct?
Which would make sense if a “flight from land” was the reason for hitting the ZLB. But suppose that land is considered a safe haven asset, or for some reason happens to be overvalued when the ZLB is hit. What good would buying it do?
(I’m not arguing about whether the CB can control the price level via land – just whether it’s a solution to the ZLB).
ATR/JKH
I think we’re on the same page. Nick’s land example seems to me to be less like our modern world and more like the WWII scenario you mention, when the Fed directly set bond and bill prices (it had ceased to enforce the gold peg).
If Nick’s example were to be like our world, then the Fed would be buying and selling land to enforce the rental rate on reserves (the overnight rate), not to enforce the price of land, which would stay floating. I don’t see the modern day Fed as targeting bond prices, just setting an amount it’ll buy and letting prices bob about.
Barkley, the rentenmark was implemented to help stop the inflation — it had a stable value thanks to its claim on property.
http://jpkoning.blogspot.ca/2012/12/how-to-stop-hyperinflation.html
http://jpkoning.blogspot.ca/2013/01/rudolph-havenstein-independent-central.html
Nick Rowe: “Real factors determine relative prices; so if the CB controls one nominal price that determines all nominal prices.”
That assumes that price ratios remain the same when the price of one thing changes. Something that we do not see in real life. Something that ignores psychology. Something that assumes no constraint on money.
Given a monetary constraint, for instance, a rise in the nominal price of land might lead to a rise in nominal housing rents, which might lead to a lower ratio of the nominal price of movie tickets to the nominal housing rents, as a monetary constraint constrains household budgets. Movie tickets might go up, but by not as much as the price of land.
Ralph Musgrave: “Min,
“As you’ll see from my above answer to Nick, I pretty much agree with you. Though I don’t agree with SPECIFICALLY targeting the poor,”
Thanks, Ralph. Me either. 🙂
Nick Rowe: “Real factors determine relative prices”
I guess one thing that I am trying to say is that there is no such thing as a real price ratio between movie tickets and land, not even in the long run — especially in the long run. I don’t mean that there are no real price ratios, but, as J. P. Morgan said, “Prices fluctuate.” They are nominal, they are psychological, they are ephemeral.
JKH – okay, I stand corrected, that Fed primer is good, but that’s from the same family of thought to which Woodford/Bindseil belong. In other words, I could have said ‘see this paper’ instead of see ‘Woodford / Bindseil.’ For example, the Whitesell papers it cites to support its explanation of how it works themselves cite Woodford 2001. Others in that family of research cite Bindseil. Moreover, that was published only recently in 2008, and though Poole was on the right track in 1968, that line of thought practically vanished from the literature until the late 1990s/early 2000s. From what I can tell from general discourse, it’s still not widely known or understood outside of that circle of authors or people who research / work in that area. Lastly, I think getting inside of the math helps add a level of insight not provided in that paper, but that’s just my opinion.
ATR
Not trying to correct you, or be dismissive in using the word “standard”.
Whether Keister, Woodford, or Bindseil or a few others – its’ all good and its how central banks work – but not known nearly well enough, as you say.
I use the word “standard” as meaning the guys who get the facts right.
🙂
JKH, I don’t think I said that right. Assume nobody wants currency anymore. People turn it into the commercial banks for demand deposits. The commercial banks turn it into the fed. The fed does not say no. The fed will exchange currency for gov’t bonds.
With QE and if commercial banks try to exchange central bank reserves for gov’t bonds, the fed says no to the exchange of central bank reserves for gov’t bonds.
Correct?
J P Koning
“the rentenmark was implemented to help stop the inflation — it had a stable value thanks to its claim on property”
The “it had a stable value thanks to its claim on property” apparently isn’t quite correct. The story is rather complicated.
The stability came from it being a (dollar) indexed “wertbeständiges” currency in an economy that was by now dominated by them and by the extremely tight monetary policy of early 1924.
However,
“While Germany enjoyed monthly small trade surpluses of 68 million and 93 million gold marks in the last two quarters of 1923, in the first two quarters of 1924 average monthly trade deficits of 212 million and 323 million gold marks were observed.”
Click to access Ch10.PDF
The rentenmark bought time until the Dawes loan, after which capital inflows financed the trade deficit.
This story really makes a great deal more sense than the “magic of the rentenmark”.
“It was only in 1925 that there was a massive return of funds, as measured by the very large unaccounted capital inflow of approximately US$ 481 million shown in Table 10-5. This seems to suggest that the decisive factor in securing confidence on the stabilization was not the spell of dear money enforced in the spring of 1924 but some event taking place later in 1924, most likely the approval of the Dawes plan in August and the floatation of the Dawes loan in October”
BTW the paper argues that the cause of the transition to hyperinflation was the marginalization of the mark by the huge amount of better “wertbeständiges” currency – a fall in demand.
PeterN, leave a comment on my blog if you want to discuss the rentenmark, Nick is probably grinding his teeth at this off-topicness.
JP: Nick is fine. I get annoyed with off-topicness early in the comments, but once the main topic has been discussed thoroughly, we can wander a bit. Some very interesting sub-themes here. Carry on about the rentenmark.
TMF:
The Fed exchanges currency for bank reserves on demand.
As a separate step, the Fed has the option of selling bonds or doing something else to drain bank reserves if necessary.
The commercial banks can’t buy bonds from the Fed unless the Fed decides first it wants to sell bonds.
But the banks on demand can buy currency in exchange for reserves.
ATR:
“The way central banks are run now, they don’t refuse to take back currency for gov’t bonds? Right?”
Correct. I like to think of a case where a bunch of holders of paper dollars are on their way to the bank, aiming to redeem their dollars for gold. But the bank knows they are coming and uses its bonds to buy back a bunch of its dollars. This soaks up the unwanted dollars, and the dollar holders decide they don’t want to redeem their dollars for gold after all.
Barkley Rosser:
“Probably the most famous case was the German rentenmark, although hyperinflation in the 1920s led to its demise, with this supposed land price anchor providing no stability in the end.”
Land makes perfectly good backing for money, and if you issue $100 against land that is worth 100 oz. of silver, then $1=1 oz. The problem is that the Germans issued 100 million rentenmarks against land that was worth only 100 oz, so of course there was inflation.
Nick would any tradable asset work in place of land? What about something that occupies an almost inconsequential part of the economy?
Could the CB, for instance, buy and sell autographed baseballs by Babe Ruth to control the economy?
primed; good question. For inflation targets of around 2%, currency demanded is around 5% to 10% of GDP, in most advanced economies. So you would need some asset whose total value was at least 10% of GDP. Plus, it would be nice if the central bank earned some income from owning that asset, or renting it out. So land would work OK, but autographed baseballs probably wouldn’t.
Nick’s post said: “ATR: “I think Nick’s point is that he doesn’t care where rates wind up, as long as he achieves his land price target. He thinks the land price target is enough for the CB to achieve its objectives.”
Yep.”
I think it will be more complicated than that.
Monetary base could go up. Demand deposits could go down.
Monetary base could go down. Demand deposits could go up.
In both cases and with 1 to 1 convertibility (relative pricing) between currency and demand deposits, both currency and demand deposits are MOA and MOE. MOA does not have to be monetary base.
Also, let’s assume Apple and Warren Buffett have accumulated a lot of land and gov’t bonds because of excessively positive real earnings growth and saving. Start at year 0 with both Apple and Buffett not wanting to spend on goods/services for at least 20 years. They are both using land and gov’t bonds as savings vehicles. In year 2, debt defaults and debt repayments cause demand deposits to fall so that MOA falls. The fed buys land and bonds in the exact amount that demand deposits fell, probably overpaying for the assets. Apple and Buffett both yawn about the demand deposits and hold them as a savings vehicle. MOA in circulation remains at where it has fallen too. There is still a shortage.
Mike Sproul at 5:22, I think that was my question.
JKH, let’s say the fed funds target is 1.5%. People no longer want to hold any currency. They swap currency for demand deposits. [The commercial banks swap the currency for central bank reserves.] The [] part always happens. The fed does not refuse to take back the currency?
Next, the fed funds rate starts falling towards zero. Most likely, the fed will swap a treasury for the central bank reserves. The fed could pay IOR? The fed could raise the reserve requirement?
JKH, do you think demand deposits are MOA?
TMF,
– no the Fed does not refuse
– yes, any of those
– I’m unschooled in MOA; Scott Sumner probably has the best definition
JKH, ATR, Nick,
Regarding the setting of interest rates for reserve liquidity when the CB does not target rates:
The CB of Singapore (Monetary Authority of Singapore) targets SGD exchange rates (technically a nominal effective exchange rate on a basket of currencies within a defined band with a defined drift). Hence domestic interest rates should be ‘market determined’. The precise specification is
“6 The MAS Standing Facility is unique [1] in that interest rates under the Facility will be based on a market-determined rate. This is determined on a daily basis via an auction of overnight clean borrowing from Primary Dealers in the morning of each working day through MAS’ daily money market operations. The weighted average of successful bids will form the reference rate for that day. The rate at which Primary Dealers may borrow from the facility will be 50 basis points above the day’s reference rate, while the deposit rate will be 50 basis points below the reference rate.
7 The introduction of the Standing Facility does not represent a departure from MAS’ exchange-rate based monetary policy, and does not constitute a mechanism for interest rate targeting. ” (http://www.mas.gov.sg/news-and-publications/press-releases/2006/mas-launches-electronic-trading-platform-for-sgs.aspx)
Clearly there is a daily floor and ceiling, but those rates are not set by the CB (at least not directly – the expectations of SGD NEER does tend to set rates relative to Fed rates). Today the deposit rate is 0.00 and the borrow rate is 0.62.
Nick,
it seems to me a corollary of this is that real factors must determine the real interest rate. I may at one time have believed this, but I don’t anymore – the evidence is simply against it. I think this is a dilemma for monetary theorists, but I guess that the key lies in the anomolous behaviour of exchange rates. Quite simply, international financial flows do not equalise real rates of return in the real world, so that an increase in leverage pushes down real rates of return (partly because of the bias in lending policies towards lending for purchase of assets – regardless almost of the rate of return).
Oops
this was commenting on something that nick wrote in a comment
” Actually, it’s a lot easier to see how a central bank can control the price level by controlling the nominal price of land than it is to see how it could do it by controlling the nominal interest rate. Because you don’t get the Steve Williamson/Kocherlakota problem. It’s totally standard classical dichotomy, for the long run result. Real factors determine relative prices; so if the CB controls one nominal price that determines all nominal prices. Sure, nominal interest rates will change too, if the CB changes the growth rate of land prices. And real interest rates will change too, in the short run, if the CB changes the price of land and prices are sticky. The Price/rent ratio for land is (the reciprocal of) a (very long term) real interest rate.”
Min
”
I guess one thing that I am trying to say is that there is no such thing as a real price ratio between movie tickets and land, not even in the long run — especially in the long run. I don’t mean that there are no real price ratios, but, as J. P. Morgan said, “Prices fluctuate.” They are nominal, they are psychological, they are ephemeral.”
My guess is that land is a REALLY lousy example. Land is a positional good. It gobbles up excess (so that part of its value is its price – and increasing taxes will definitely reduce the relative price of land). And there is no such thing as “the price of land” (- every piece of land is unique, whereas every dollar is the same).
By the way, I think this whole paragraph is completely nuts:
“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.”
If a central bank raises land prices – then everybody then it will mean that people buying houses will have to go deeper into debt and so will spend less on other things – making investment in newly produced capital goods relatively LESS profitable (and also drying up investment funds for other purposes). An increase in land prices (which will eventually feed through to rents) is exactly like a tax increase. And there is no such thing as equlibrium (because the change in relatively asset prices will change the distribution of wealth – which will then agains change the “equilibrium” ad infinitum).
Oops
That last sentence came out completely mangled.
“And there is no such thing as equilibrium (because the change in relative asset prices will change the distribution of wealth – which will then again change the “equilibrium” ad infinitum). Non-independence of the the mechanism and the target happens with monetary policy as well as with fiscal policy. I simply don’t like the concept of “equilibrium” – we are never at equilibrium and will never be at equilibrium. We can push things one way or the other, but it is better to keep on eye on where we actually are than to assume we know where we are going.
Squeeky W.,
I believe Singapore is a currency board arrangement?
If so, that’s very different, and the exception when it comes to interest rate policy targeting.
Squeeky: good comment. That’s almost exactly the sort of thing I had in mind. Just replace Singapore’s basket of currencies with land. (Though land is a bit less liquid. But hey, I only meant it as a metaphor anyway.)
JKH said: “I’m unschooled in MOA; Scott Sumner probably has the best definition”
I cringe just hearing that one. Let’s work on it because Scott Sumner says MOA is monetary base (currency plus central bank reserves). If he is right, then banking should not matter. I believe banking matters. I think you believe banking matters too.
Let’s start here:
http://jpkoning.blogspot.com/2012/11/discussions-of-medium-of-account-could.html
“JP Koning December 9, 2012 at 1:13 PM
The definitions I’m using for medium of account, unit of account, and medium of exchange come from NME (see comment above). Here is an example:
“A medium of exchange is an asset that is widely accepted in trade and to settle financial obligations. Currency notes or transferable bank deposits are typical examples. A medium of account is the commodity defining the unit of account. A unit of account is a specific amount of the medium of account. For example, for the gold standard the medium of account is gold, while the unit of account might be one ounce or one pound of gold of specific purity. A unit of account is the unit in which the medium of exchange and other assets are denominated and in which other values and prices are expressed.”
Warren Coats, 1994.”
I’m not completely sure about the last sentence.
Also, http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/10/medium-of-account-vs-medium-of-exchange.html
“[Update: just to clarify terminology: in my model, gold is the medium of account; and (say) an ounce of gold is the unit of account.]”
I agree.
And, “All prices are quoted in ounces of gold.”
Let’s start there. I agree. Nick might be shocked I agree with him.
Using a gold standard with no banks, gold is MOA and one ounce of gold is UOA. There are 1,000 ounces of gold. Gold is not used as MOE at first. If V of gold = 0, then NGDP = 0. That is a problem. Solution: Add currency as MOE. Fix convertibility at 1 ounce to $1 (relative pricing). Everyone turns in their gold for $1,000 in currency. The currency entity gets the 1,000 ounces of gold. Everyone now quotes prices in terms of gold and currency at the same price because of the 1 to 1 convertibility. The $1,000 in currency starts circulating with a velocity of 2. NGDP = $2,000. Sound good so far?
TMF,
For convertible currencies, MOA is the object of conversion (e.g. gold)?
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.
Also, banks are guaranteeing customers convertibility of their deposits into currency, and the CB is guaranteeing the banks convertibility of their reserves into currency. So what the banks offer to customers as deposits depends on the monetary base as MOA.
That’s my guess.
JKH,
Base money is the MOA for bank money, that’s clear. But in my opinion it doesn’t make sense to say that base money is the MOA for base money (or that there’s no MOA). The MOA for base money is whatever the central bank is targeting (e.g. a price index).
In theory, the Fed could offer gold convertibility (not at a fixed price!) without changing its target in any way. The MOA would remain a price index, and the gold market would have no effect on prices in general (unlike the gold standard).
JKH said: “For convertible currencies, MOA is the object of conversion (e.g. gold)?”
In my example (fixed/pegged convertibility), gold and currency are both MOA. There is a dual MOA. Everyone quotes prices in terms of gold and currency at the same price because of the 1 to 1 convertibility.
From my example above (fixed/pegged convertibility), 1,000 ounces of gold have a velocity of zero at the currency entity, and $1,000 in currency have a velocity of 2.
Now mine another 1,000 ounces of gold and have gold be MOE as well as MOA. Everyone keeps their original $1,000 in currency. Another $1,000 in currency needs to be available to maintain the fixed 1 to 1 convertibility. 1,000 ounces of gold have a velocity of zero at the currency entity and 1,000 ounces of gold have a velocity of 2. $1,000 in currency have a velocity of 2, and $1,000 in currency have a velocity of zero at the currency entity. NGDP = 4,000.
Now have everyone panic and not want to hold any currency/use it as MOE. They swap for gold. 2,000 ounces of gold have a velocity of 2. $2,000 in currency have a velocity of zero at the currency entity. NGDP = 4,000.
Now have everyone panic and not want to hold any gold/use it as MOE. They swap for currency. 2,000 ounces of gold have a velocity of zero at the currency entity, and $2,000 in currency have a velocity of 2. NGDP = 4,000.
Notice the fixed/pegged convertibility leads to a dual MOA. Sound good?
Now make it more interesting. Get rid of the gold standard and replace it with a demand deposit standard where “mining” more demand deposits relates to the capital requirement/ratio.