Consider three positions:
1. The stock of money is determined by the demand for money, and not by the supply of money.
2. The stock of money is determined both by the demand for money and by the supply of money.
3. The stock of money is determined by the supply of money, and not by the demand for money.
In my last post, I showed that the first (demand only) position was wrong. The central bank's supply function matters too.
Most reasonable economists, who understand the distinction between supply (function or curve) and quantity supplied, who understand that the interest rate target is endogenous with respect to the stock of money, if inflation is to be kept on target, will say that the second position (both demand and supply) is the sensible position to take (unless the central bank has a perfectly inelastic supply function).
But I now want to argue for a more extreme position. I now want to advance deep into enemy territory.
Suppose, just suppose, that the central bank does target an exogenously fixed rate of interest, and ignore the Wicksellian indeterminacy this creates, and ignore the fact that this is incompatible with targeting inflation or anything vaguely sensible. That interest rate target is the central bank's money supply function, and a change in that interest rate target money supply function will cause a change in the stock of money.
Will it be true that the actual stock of money will always be equal to and determined by the quantity of money demanded at that target rate of interest?
Any sensible economist, who accepts the sensible middle-ground of position 2 (both demand and supply) would answer "yes". I will answer "no".
It is hard for me to explain this clearly, so please let me simplify as much as possible.
Let us consolidate the commercial banks and central bank into one big central bank that prints money and lends that money directly to people at a rate of interest it sets. The money itself (think of it as currency) always pays 0% interest, but the bank charges r% on loans of currency.
Ignore risk on loans. Anyone who wants a loan from the central bank can get one, at the rate of interest r, and they never default.
Take the standard assumption that the demand for money (the average stock of money people wish to hold) is a positive function of P and Y, and a negative function of r (the opportunity cost of holding money that pays 0% interest). Md=L(P,Y,r).
In this economy, the (change in) the stock of money is determined by the supply (function) of money (i.e. the rate of interest set by the central bank), and by the demand for loans. It is not determined by the demand for money. P and Y will (eventually) adjust until the quantity of money demanded equals the quantity of money created by the supply (function) for money and the demand for loans. The supply (function) of money, and the demand for loans, together determine the quantity of money created, and that quantity created (eventually) determines the quantity of money demanded.
It should be obvious really. When people borrow money, they (usually) borrow it to spend it; they do not (usually) borrow it to leave it in their pockets. Because money is the medium of exchange.
Take a simple example, just to illustrate my point. Suppose, just suppose, that the demand for money were perfectly interest inelastic. Desired velocity is fixed. So the money demand function is Md=L(P,Y)=PY. (Yes, I know that this assumption is empirically false, but just suppose.) Given this money demand function, the rate of interest set by the central bank has no direct effect on the quantity of money demanded. If the stock of money was determined by the quantity of money demanded, the central bank would be powerless to do anything that would cause the stock of money to increase. Cutting the rate of interest would not work. But we know it will work, provided the quantity of loans demanded depends on the rate of interest. By cutting the rate of interest, the central bank increases the quantity of loans from the central bank, which creates more money. Eventually P and/or Y will increase and the quantity of money demanded will increase in proportion to the quantity created.
The supply of money determines the quantity demanded, and not vice versa. Even with a perfectly interest-elastic supply function, at an exogenously fixed rate of interest. Money is weird like that. The medium of exchange is not like other assets.
I have made this point before, in many different ways. This seemed like a good time to make it again. Maybe it's clearer this time.
Worthwhile Canadian Initiative 
Nick,
“Yep”.
Nope. Rising CPI inflation does not cause terminator robots to shoot people in the street. Terminator robots shoot people in the street because evil robot lords program them to shoot people in the street. If the robot lords decided not to send out their terminators no terminators would go on murderous rampages. The robot lords decide to send out their terminators because they are crazy and evil and think that this is the right way to control inflation.
Rising CPI inflation does not cause the central bank interest rate to rise. The central bank interest rate rises because the central bank decides to raise it. If the central bank decided not to raise the interest rate the interest rate would not rise. The central bank decides to raise the interest rate because they think this is the right way to control inflation.
Any similarity between evil robot lords and central bankers is purely coincidental.
Philippe, what if the evil robot lords all die off, but no body can figure out how to turn off their self-sufficient terminator robots, and they continue shooting people in the streets every time CPI rises from now till the end of time? Still “Nope?” And what if additionally it turns out the so-called evil robot lords were actually just a group of monkeys fooling around in the lab, who just accidentally programmed the terminator robots? Still “nope?”
I was interested to read that new Keen paper. It clearly inspired by Nick’s earlier post (that he reprises above).
Keen now thinks that AD increases by the change in debt * V. Isn’t the “hot potato effect” implicit in his V ? I borrow $100. The $100 then “hot potatoes” around until we reach a new equilibrium. That’s just velocity of money in action applied to an increase in M , right ?
The odd thing is that this V presumably includes people parking some of their new higher income in the bank where it will be lent out again and further add to AD. There seems to be an implicit money multiplier hidden in Keens new model.
Its also odd that Keen ignores govt deficit as a source of increase in AD.
The Market Fiscalist, Mark Sadowski pointed out that Keen is implicitly assuming V is constant… or that he’s doing the math wrong:
http://www.themoneyillusion.com/?p=26219#comment-319483
Holding V constant is part of why he joked (see my above link) that Keen is now an old school monetarist.
Philippe: “Rising CPI inflation does not cause the central bank interest rate to rise. The central bank interest rate rises because the central bank decides to raise it.”
By that same argument, a higher price of apples does not cause me to buy fewer apples. I buy fewer apples because I decide to buy fewer apples. The quantity of apples I buy is exogenous.
Tom: don’t tell anyone, but I don’t actually know what Lebesque integration is. (Or, I don’t think I do). I’m pretty sure Steve Keen held V constant for simplicity, just like I did here, because it didn’t really affect his point much.
TMF: “Keen now thinks that AD increases by the change in debt * V. Isn’t the “hot potato effect” implicit in his V ? I borrow $100. The $100 then “hot potatoes” around until we reach a new equilibrium. That’s just velocity of money in action applied to an increase in M , right ?”
Yes. I think that’s right.
“Its also odd that Keen ignores govt deficit as a source of increase in AD.”
Presumably for simplicity, because it didn’t affect his main point, just like I ignored it here.
Nick, your Lebesgue secret is safe w/ me! (BTW, I suspected that might be the case, but I didn’t want to presume and put a smiley just in case). Re: V constant: maybe you’re right, but given that he spends effort making the rest more complicated, it’s hard to believe… and not only that but Sadowski is right!… hold V constant and Keeen’s math reduces to the exchange equation w/ constant V. Old monetarist, no?
“Suppose, just suppose, that the demand for money were perfectly interest inelastic. Desired velocity is fixed. So the money demand function is Md=L(P,Y)=PY.”
But what if Md = PY/V? And suppose V changes. I’m thinking of a basic IS-LM model with LM given by M = PY/V. If you work out the equation that shows how M depends on the model’s exogenous variables under a fixed interest rate policy this equation will have V on its right-hand side (as well as everything else that shifts the positions of the IS and LM curves). But then how can we say M is independent of the demand for money?
The case we’re considering here reminds me of the IS-LM analysis of an economy under a fixed exchange rate. In that set-up Y is determined by only the IS curve and the world interest rate r*. The demand for money doesn’t enter into it. That’s because under a fixed exchange rate the central bank must automatically accommodate any change in the demand for money by changing the quantity of money. Here again, Y doesn’t depend on the demand for money but M does.
Most of the above discussion went over my head, so apologies in advance if this has already been deal with.
HJC, “But I think the problems are more fundamental than whether the maths is correctly done or not.” I agree, I’m wondering what the point of some of the math is… it would make it easier to evaluate its correctness.
This current post has made me realize the commonality there is between the “endogenous money” theorists and the kind of monetary theory done by Nick.
Both recognize that an increase in the demand for credit can drive an increase in M , AD and Y. Nick focuses on the generic affects the increase in the money supply will have and the control mechanisms that can be used to maintain stability, while the “endogenous” guys like Keen tend to focus on the increase in credit as something worthy of independent study (I think they follow Minsky in seeing debt-levels as one of the main drivers in the business cycle ?).
Question: is there any fundamental difference between a change in AD due to a change in V, compared to change in AD due to change in the demand for credit? I suspect Keen would say there is because (he would argue) in the run up to 2008 there was an unsustainable increase in the demand for credit that must (logically) have been accompanied by a decline in V since AD stayed on a steady growth path for the 2 decades before.
O/T: which English speaking regions use “maths” … I’m from California, and I swear I’d never heard “maths” (only “math”) until the last few years. Have I been guilty of a regionalism this whole time?
Nick, I checked where I used “supply” and I intended the curve every time. Did the curve not apply in some cases?
Tom,
Canadians use ‘mathematics’
British use ‘maths’
Australians use ‘Lebesgue Integration’
The Market Fiscalist,
“Is there any fundamental difference between a change in AD due to a change in V, compared to change in AD due to change in the demand for credit?”
Careful here. I think what you mean to ask is “Is there a fundamental difference between a change in AD due to a change in liquidity preference, compared to a change in AD due to a change in demand for credit?”
The liquidity preference of borrowers is presumed to be zero – they borrow money to immediately spend it. The liquidity preference of holders of money can be anything from zero to one.
And so AD and velocity are affected by both credit demand and liquidity preference.
JKH, Funny! … BTW, Matheus’s post was funny too… he sounded like he’d been harried by the “accounting police.” Did he ever win them over?
JKH,
Lol. Indians use Dirac Delta Functions 🙂
Tom,
Yes Brits use ‘maths’. For you it is ok but India has got Americanized and I feel inflamed if Indians used ‘math’ because in school here we say ‘maths’ (although I have made this mistake too). Worst was an Indian school teacher Twitter status I saw which said it was always math and not maths!
The Market Fiscalist,
“This current post has made me realize the commonality there is between the “endogenous money” theorists and the kind of monetary theory done by Nick.”
Allow me to quote Mark Sadowski:
“So, in short, there is no such thing as “exogenous money” theory. (Where’s the Wikipedia page?)”
http://tinyurl.com/ot7k9s7
Majromax: each individual borrows money from the bank, planning to get rid of it, by buying something from another individual. But he doesn’t realise that every other individual is planning on doing the same thing. So at the end of the period he is surprised to discover that for every extra $1 he spent he got an extra $1 in sales (on average across individuals), so his stock of money is higher than he had wanted it to be. Individually each one borrowed what he wanted to borrow. Collectively they all borrowed more than they wanted to borrow, and now hold more money than they want to hold. So the process doesn’t stop there. But how exactly the process unfolds from then on depends on how they revise their expectations.
Only if individuals were indifferent to how much money they held, regardless of income, spending, interest rates, anything, so their current stock of money had no effect on their plans, could we ignore the demand for money and their actual stock of money.
Maurice: Start in equilibrium, then suppose V decreases (but nothing else changes). I think (given my assumed money supply function) the only effect would be an increase in loans from the central bank, where people borrow the extra money they want to hold. In this case only, the increase in quantity of money demanded would cause the increase in the actual stock. They borrow extra money because they want to hold extra money, rather than spend extra money.
When I said: ” When people borrow money, they (usually) borrow it to spend it; they do not (usually) borrow it to leave it in their pockets.” This is the “unusual” case.
I think you are getting it.
The ISLM representation is a bit weird. We have a vertical LM curve for a given M, plus a horizontal LM curve for a given r, and the vertical LM curve will shift right over time if the bank is making positive net loans. But the economy will be “off” both the IS curve and the (vertical) LM curve in the short run, because actual income does not equal expected income, and actual M does not equal M demanded.
TMF: Yep. I focus on M. “Credit” matters insofar as it influences M. Individuals borrowing and lending amongst themselves doesn’t matter (much). It (mostly) only causes a redistribution of demand.
On your question: see my response to Maurice above.
Ramanan, I’m used to being taught how to speak my language by foreigners. Californians in particular could use a bit more of that. Worst was a student from Germany lecturing me on the proper use of “who,” “whom,” “could,” and “would.” He was right of course.
“Philippe: central banks adjust the money base to hit their interest rate target, and adjust the interest rate target to hit their inflation target. Everything they do is “according to their theories”, and depends on what is happening in the economy.”
Nick – I’m on look-out here :). I thought we had reached an agreement that hitting a central bank’s interest rate target is not just about adjusting the monetary base. It depends on the system and tools the central bank choose to employ. It should be readily acknowledged that countries that operate a symmetric channel system try not to adjust the money base to move the target. The whole point of the system is to make the central bank’s life easier by allowing them to mostly just change their administered interest rates to hit their target – this was all made clear in that Woodford paper, among many other articles.
(Of course acknowledging the adjustment of quantity to stabilize a given rate.)
Nick, in your example of 10:12, isn’t the final stage that the RA pays back the $100 loan with the cash-flow from the extra income. Even in an equilibrium case there is a need for this kind of circular flow of credit because of the mismatch in timings of expenditure and income. Surely that’s what credit money is for. But how is it a hot potato?
On another matter, a key aspect of the pure-Endogenous money theory is the reversal of the causality in the equation of exchange. Clearly Tom’s comment above has shown that this is not the case in Keen’s model – it is more accurately described as an (old school) monetarist model. From the early days of the theory it was always claimed that money was an effect not a cause.
I think Keen is making a mistake (category error?) in trying to add new financial debt, which is a money/credit cash-flow, to expenditure which is a contract for exchange, i.e. another form of credit. They are in different realms, the former is used to settle (with respect to the seller anyway) the latter. It’s a form of double-counting where basic concepts of income statements (or profit and loss accounts) are confused with cash-flow statements.
Nick, I think I’ve got my epsilon problem. Real demand for money = Mdr, nominal demand for money = Mdn, nominal supply = Ms, and the price level starts off at P0 = CPI. On the x-axis (dependent variable) is nominal demand and supply for money, while y-axis (independent variable) is 1/P. What’s plotted is Mdn as a function of 1/P with Mdr fixed: Mdn = Mdr/(1/P). The supply curve is x = Ms = epsilonMs0, i.e. a vertical line at x = Ms. As epsilon approaches 0, real demand for money also falls proportionately as Mdr = epsilonMdr0. Starting out at epsilon = 1, we know that Ms0 = Mdn0 = Mdr0/(1/CPI), which is still true as epsilon goes to zero because epsilonMs0 = epsilonMr0*CPI. Thus P = CPI still (P does not change). What are some examples of minimal changes I could make to my hypothetical so that Mdr remains fixed at Mdr0 instead of being proportional to epsilon? Introduce a second commercial bank? Something else?
HJC, looking at it again, Mark did make some simplifying assumptions (he was clearly making a joke more than anything else). But he did accurately identify that deltaV = 0 (in the 2nd link to Mark I provided), else Keen’s math wouldn’t work. But Nick could be right… Keen does keep V a function of time, so perhaps he assumes it changes very slowly, ignores the deltaV terms as small, and just adjusts V to to the new time interval?
Hi Tom, it doesn’t really matter too much about what his assumptions are regarding V. If he assumes that the causation runs from MV to PQ/Y then it’s not really a Post Keynesian model, it’s more of a monetarist model.
Out of interest, how many Tom Browns are there commenting on this blog? Or is there just one that never sleeps?
Just one insomniac. 😀
ATR: there are many many ways a central bank could target inflation. For example, it could buy and sell gold, and adjust the target price of gold up and down, like Irving Fisher’s “Compensated Dollar” plan. If Philippe is going to argue ‘but real world central banks adjust an interest rate target’ to keep inflation on target, then I will adopt the same mode of argument and say that the real world Bank of Canada (nearly always) keeps those spreads fixed at 25 basis points! It could vary those spreads, as you suggest, but it could also buy and sell gold, or farmland, or whatever.
And if they used a varying land price target to hit their CPI inflation target, they would never have to worry about the ZLB, where they have to abandon interest rate control and switch to “QE”.
HJC: “Nick, in your example of 10:12, isn’t the final stage that the RA pays back the $100 loan with the cash-flow from the extra income.”
That depends on a lot of things. If there is still a positive net (flow) demand for loans from the central bank, because the rate of interest is lower than equilibrium, that won’t happen. To restore (ISLM) equilibrium, we need the representative agent to have planned expenditure equal to his expected income. Every time he changes his plans in response to surprises in his actual income, he changes his actual income. It is not at all obvious whether and how this learning process will converge to an equilibrium.
There are 2 LM curves: one for the interest rate set by the central bank, and one for the existing stock of money. What process ensures they both cross the IS curve in the same place? Especially since it’s not at all obvious the IS curve slopes down, given the accelerator effect on investment of increasing income. The central bank may need to deliberately stop the process, by raising the rate of interest.
Sure – fine. You just sounded particularly attached to the need to change some sort of quantity there. Although I’m not quite following why you think keeping a fixed spread but moving it around (e.g., 1-2% to 3-4%)is a counter to the idea of changing the width of the spread. Moving a fixed spread can still move the interbank rate to a new target without adjusting quantity of reserves, all else equal. Or maybe I’m just missing your point…
Nick: For me to be able to understand this, I might need to resolve some of these issues: Who is the RA borrowing from? Why would there be a positive flow of loans when all agents are the same? I can see that we are not using rational expectations, but what about some sort of adaptive expectations where the agent eventually realises that his expenditure and income are always the same? Can the agent buy assets from the bank/lender to get rid of unwanted deposits to restore equilibrium via the asset markets? As it stands it’s hard (for me) to appreciate what insights can come from analysing a model that wasn’t really designed to have a natural place for inside money. But I think this may be all too much for a comment chain!
The idea of two LM curves is interesting, thanks. I’ve managed to wander quite far from simply correcting a few Post Keynesian representations.
HJC: With identical individuals, the representative agent would know that if he was planning to increase spending by $100, then he would know every other agent was planning to do the same, so would expect his income to rise by $100. But if there are aggregate shocks and individual-specific shocks to planned expenditure, and each individual only observes the sum of the two shocks, the representative agent would not know he is the representative agent. He gets a shock and thinks it is (partly) specific to him, so when he increases his planned expenditure he does not expect his income to rise by the same amount.
With imperfect information, and enough different shocks (aggregate/individual, and permanent/temporary) this is all compatible with rational expectations.
My mental model has each agent being able to repay a loan at the bank any time he wants. But if the interest rate is low, he won’t want to. Instead he spends his excess money. And then is surprised to find it comes straight back to him, in the form of higher income! Income rises until the extra stock of money is willingly held.
Nick: This is what I think you are saying: the agent, because the interest rate is low, just wants to keep on spending, never paying back the original loan, even though his income has increased. But since the other agents are doing this too he also has an unexpected increase in deposit balances. Everyone’s income has increased. But instead of repaying the loan with his increased balances, he spends it (again).
But the rate of borrowing and spending is not ever-increasing, is it? It’s just a one-off increase, because the agent doesn’t know whether the increased income is permanent, even though it is. My question is: isn’t this just the same as saying that the agent receives an unexpected $100, repays his loan, then, because interest rates are still low, borrows $100 to spend, repay etc. When put this way is there really anything that can be called an increase in the money stock?
HJC: Suppose the central bank bought and sold apples, at a fixed price of apples, instead of buying non-monetary IOUs, at a fixed rate of interest. There could never be an excess supply or excess demand for apples, at that fixed price of apples. Anyone who held too many apples or too few apples would immediately sell them to the central bank or buy more from the central bank. But does that mean there cannot be an excess supply or excess demand for money? There could still be an excess demand or supply of all other goods, if the central bank set the price of apples too high or too low (assuming other prices are sticky).
For example, start with all markets in equilibrium, then suppose the central bank lowers the target price of apples. People buy apples from the central bank, and the stock of money shrinks, and (unless the prices of all other goods fall immediately in proportion) we get an excess supply of all other goods, and an excess demand for money, in all other markets. Setting the price of apples too high causes an economy-wide recession because it reduces the stock of money in circulation.
We find it hard to distinguish between the demand for loans from the bank (the supply of non-monetary IOUs to the bank) from the demand for money. It is much easier to distinguish between the supply of apples and the demand for money. That is why this old post I wrote makes the same point more clearly than this one does, even if it is less “realistic”.
Nick: I can see that I’m going to have to spend some time thinking about apples. Will return when (if!) I have anything useful to say about them. Many thanks for your patience and time.
HJC: and thank you for your very good comments.
so i think the idea of money supply can be thought of as the money out there as cash, or at least very liquid and this is important in monetary theory, because that cash will be looking for a place to get return, interest rate versus marginal efficiency of capital as per keynes
but money supply also should be thought of as all the total money that could be liquidated,
bonds owed by the government that could be cashed in, loans backed by government, etc
(I dont think it should include the IOU money that banks create by, you know, not actually transferring the money, so the same money supply can be loaned several times, supposedly increasing the money supply…. because both the interest and principle paid on the iou money loans must be in real money (backed by government))
because where as monetary stimulus is basically increasing the liquid money supply
fiscal stimulus is a transfer of percentage of money supply from low multiplier place to high multiplier place, so for that purpose you cant just consider cast in circulation, but total money supply
I think thats basically what keynes was getting at
Test
Ms=8.33 @ epsilon=1
Nick: I’m on-side with your apples’ example. One thing I would be interested to know is how much of the adjustment to restore equilibrium demand for money would happen in the capital markets rather than the goods markets. Your example above relies somewhat on price stickiness, which is more a feature of goods markets. Capital market prices move continuously and can adjust readily to maintain any arbitrage/equilibrium relationships.
I wonder what you think of Ramanan’s post on this.
HJC: Thanks. On reflection, I think my apples story was the clearest.
On price stickiness. Suppose all prices were sticky, except the price of peanuts was perfectly flexible. So the peanut market always clears. We would then blame recessions on the price of peanuts being too low. The peanut theory of recessions. For “peanuts” read “bonds and other financial assets”, which do indeed tend to have very flexible prices (most of them), probably because they are homogenous with lots of buyers and seller.
Not sure where to find Ramanan’s post.
Nick, I just clicked on his name above (Ramanan’s):
http://www.concertedaction.com/
The top post looks interesting, but I don’t know if that’s the one
Tom: Yes , that’s it: ‘Reconciliation Of The Supply And Demand For Money’.
Thanks Nick: Now I’ll think about peanuts for a while…
HJC and Tom: thanks for that link. Yep. Very interesting, laying out the different answers to the exact same question I’m bashing my head against. Like I said, this stuff cuts across the usual “party lines”.
My underlying position is that money is not like other assets. It doesn’t have a price of its own, it does not have a market of its own, and the demand for money is a demand for a buffer stock inventory that everyone both buys and sells whenever anything else is sold or bought. So when there is an excess demand for money, trade in all goods (not just newly-produced goods) slows down. And we can’t just look at any one market to see if there is an excess demand or supply of money. Money is weird, and so the answer to the question: “what (if anything) ensures Md=Ms?” will not be like the answer to the same question for any other asset.
For example: take a standard Keynesian unemployment “equilibrium”, where all markets are clearing except the labour market. Is there an excess demand for money? Well, yes, because unemployed workers want to buy money in exchange for labour, and cannot. But that does not mean they want to “hold” (all) that extra money, except temporarily. They want to spend (most of) it.
Nick: Did you also look at the link to Peter Howells’ paper? It’s a good summary of the internal debates within the Post Keynesian tradition, you might find you have more in common than you realise.
I’m with you on your underlying position, and I have recently been thinking a lot about how Perry Mehrling looks at this stuff, which is why I keep mentioning him. At this stage I don’t understand why he doesn’t get more attention.
HJC: I have just now read the Howell paper. It is very good. Two points:
1. Minor point, but he should have his knuckles thoroughly rapped for confusing: supply (curve); quantity supplied (quantity offered for sale, that sellers would like to sell); quantity sold. His example of haircuts is totally wrong. Just because the quantity of haircuts sold equals the quantity demanded does NOT mean the haircut market is clearing. The seller of haircuts might want to sell more than he actually sells. If so, quantity supplied exceeds quantity sold, even if quantity sold equals quantity demanded. Especially when talking about money, we need to be doubly careful here. Our words confuse us.
2. More substantive. I think Kaldor and Trevithick are totally wrong. If people use extra money to pay down overdrafts, not just temporarily but permanently, this means that those same people must originally have had overdrafts that were higher than desired. They previously (before getting the extra money) had an excess demand for money, which has now been satisfied. The question is not “what would they do with extra money?” but “what would they have done otherwise, if they had not got that extra money?”. It is the effect of the extra money relative to what they would have done otherwise that matters. If they would otherwise have paid off that overdraft by buying fewer goods than they sold, and the extra money means they continue to spend as much as they earn, this means the extra money has had a hot potato effect.
Update: put it another way: that extra money has eliminated what would have been a negative hot potato effect from those people paying down overdrafts.
Yep. A lot in common. Those guys understand the question. They understand why it is a very important question (even before “QE”). They are asking the right question. (Their answers might be wrong, but that’s less important!)
Perry Mehrling is one of those people I should read more. If you have any particular suggestion, I would be grateful.
Take a very simple and really extreme real-world example: Zimbabwe. The growth in the stock of money was determined by the (Robert Mugabe’s) demand for loans from the central bank, at the (very low) real rate of interest the bank set. But RM didn’t want to hold that money he borrowed – he wanted to spend it. And the people who got that extra money didn’t want to hold it either; they (eventually) spent it, and it never got returned to the central bank (who would be stupid enough to do that with it, at very low real interest rates?). And that hot potato process bid up prices, which increased expected inflation, which made the hot potatoes even hotter and increased their velocity of circulation.
What’s more, RM could probably repay all of his borrowing from the central bank just by giving it an apple or two.
The beauty of extreme examples is you can ignore all the ceteris paribus stuff. It’s too small to matter.
Canada is exactly like Zimbabwe, except the central bank adjusts the interest rate in response to changes in the demand for loans and changes in the excess demand for money. The Bank of Canada’s interest rate is not exogenous with respect to the stock of money created.
“The beauty of extreme examples is you can ignore all the ceteris paribus stuff. It’s too small to matter.”
I like that quote. Some people just don’t get the beauty of extreme examples. 😀
Nick, what would it take for a cell of fanatical, yet highly disciplined and secretive NGDPLT terrorists, working secretly within key positions (but not leadership positions) in the government and central bank to carry out their twisted vision and successfully do 5% NGDPLT? Say one of them had the keys to the printing press room, and could sneak in after hours to print up some unauthorized reserve notes, and another one’s day job was to be responsible for “accurately” recording when reserve note liabilities were returned to the central bank. What’s the minimum sized cell of zealots required, and what would they ideally need to have as official day jobs? (BTW, these sickos are so brain washed they don’t care at all about the consequences of their actions, other than that NGDPLT is maintained at 5%, … while the official leadership of the CB is blindly doing whatever it is they are doing (say like whatever the Fed is doing now) totally unaware of this cell of traitors in their mix! What would be those unintended consequences? What damage would these terrorists do?