In The Conservative Case for QE2, David Beckworth provides a quasi-monetarist defense for the second round of quantitative easing.
He states that the purpose of QE2 is "about fixing a spike in the demand for money that has significantly hampered spending." He elaborates, "Because the monetary base has been increasing so rapidly and there has been very little inflation, it must be the case that demand for the money must be increasing even more. In fact, money demand has been so pronounced that even the previous $1.2 trillion increase in the monetary base was not enough to prevent outright deflation in 2009 or a sustained decline in core inflation (which shows the trend path of inflation) over the past two years. Thus, a significant portion of the money supply is being hoarded and not spent. This is the excess-money-demand problem."
In essence, the Federal Reserve has failed in the same regard that Milton Friedman blamed it for the Great Depression: "The fact that total current-dollar spending has remained depressed for so long means that the Federal Reserve has failed to do its job and effectively has kept monetary policy too tight." The solution is produced by the new monetary policy: "QE2, then, is a long-overdue attempt by the Federal Reserve to address the excess-money-demand problem. It will do so in two complementary ways. First, QE2 will increase inflation expectations, which should reduce the demand for money. Knowing that prices will be higher in the future will motivate creditor households, firms, and banks to start spending their money today while prices are lower. Second, QE2 will increase the monetary base, and this should begin to satiate excess money demand. Together, these developments should provide the catalyst needed to get the virtuous spending cycle started."
And, of course, lowered-interest rates are not necessarily problematic: "Note that lower long-term interest rates are not the key to QE2 working. Yes, long-term interest rates may initially drop as the Federal Reserve buys up long-term Treasury securities to increase the monetary base. But this effect will be fleeting if QE2 is successful. Once the economy starts recovering, interest rates will start increasing. Similarly, QE2 may initially cause the dollar to lose value, but by spurring a recovery QE2 will ultimately put upward pressure on the dollar."
Bob Murphy responds to Beckworth's quasi-monetarism with several Austrian challenges.
In turn, Bill Woolsey responds, once again pleading the quasi-monetarist case. David Beckworth, too, responds to Bob Murphy. He summarizes his key points skillfully: "During 2008 there emerged a surge in money demand as the housing fiasco began to unfold. This spike in money demand got even more pronounced in late 2008 with the uncertainty created by the financial crisis. Given that we have a central bank — and this is not an endorsement of the Fed — its job should be to offset and stabilize such money demand shocks. The Fed failed on this count and, as a result, what should have been an ordinary recession got turned into the 'Great Recession' of 2007-2009. Yes, this Fed failure — like its failure to raise the federal funds to its natural rate level sooner in the 2002-2004 period — is another indication the Fed is flawed. Nonetheless, we are stuck with this monopoly producer of money and have to work with it. This means the Fed should have done more to prevent the surge in money demand. Because it did not, the Fed effectively tightened monetary policy in 2008. Moreover, despite the large increases in the monetary base to date, money demand remains elevated. From this perspective, then, monetary policy is still relatively tight. QE2 is an attempt — a flawed one as I will discuss later — to address it."
He adds, "Appreciating the importance of money demand shocks also helps explain why conservative economists like Scott Sumner, Bill Woosley, Josh Hendrickson, and I are sympathetic in spirit (if not in form) to QE2. It would do all hard-money advocates some good to wrestle with the monetary disequilibrium literature and its implication for a commodity standard. It is worth noting that there are prominent Austrians like George Selgin and Steve Horwitz who take the monetary disequilibrium seriously."
I think the money demand shock, given our monopolized currency, can only be treated through the machinery of the Federal Reserve; given the excess money demand, greater supply is required.
P.S. I fully endorse free banking.
"I'm not a fan of Murray Rothbard." -- David D. Friedman
No kidding. Put a little more effort in trying to understand what people are claiming and what they're not.
No kidding.
Put a little more effort in trying to understand what people are claiming and what they're not.
Well it seemed to contradict what you had written previously,
"The use of "above the natural rate" or "below the natural rate" are valid in explaining the discoordination only on account of the economist's assumption, made for simplicity of analysis, that the "natural rate" , as a given, is the present desirable rate of the market. (emphasis on desirable). Therefore, it automatically follows that any divergence from this "natural rate" (market rate) constitutes a disruptive divergence, or distortion. However,it also logically follows that this disruptive force must be exogenous. Assuming that the cause can also be indigenous, such as voluntary changes in cash holdings, results in a logical self-contradiction, i.e., if "natural rate" is the rate of the free market, how can there be a divergence from it in the free market?"
The natural rate is not necessarily the rate of the free market. I don't know how you misunderstand this.
Pro tip: if you don't know how someone doesn't understand something, point out how you do understand
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Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
DD5:And this preference for increasing one's cash balance is time neutral as I have shown when the reduction in spending affects both present and future goods so that the final state of allocation between the two remains unchanged. The preference for the amount of cash blance is independent from time preference. One can occur without affecting the other. That's what is meant by time neutral. [Emphasis added.]
Is it? After all, by increasing your cash balance now, you're lowering your spending now, and thus indicating a higher preference for cash now as opposed to in the future. As I understand it, time preference is the amount at which future goods are discounted with respect to present goods.
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Zachary Plaxco:The natural rate is not necessarily the rate of the free market. I don't know how you misunderstand this
Enlighten us please..
Autolykos: As I understand it, time preference is the amount at which future goods are discounted with respect to present goods.
This is correct, but when one increases his cash holdings, is he lowering his spendings on consumers goods or producers goods?
You've indicated before that you acknowledge that time preference can even increase when one increases his cash holdings. Have you changed your mind?
Danny Sanchez: Esuric, This is the part that doesn't make sense to me. When we're talking about people demanding, "additional real money balances", we're talking about demanding more purchasing power, right? But how can wanting more purchasing power be "satiated by an expansion in the supply of money" when expanding the supply of money does not expand total purchasing power, since at any given moment, there is a definite stock of commodities (that which one can have the power to purchase) in the market, and therefore there is a fixed, definite amount of purchasing power to go around? When there is an increase/decrease in the money stock, and the demand for purchasing power remains the same, there will be an increase/decrease in the general market demand for the monetary unit (nominal cash balances). And that can be satiated by dishoarding/hoarding, while purchasing power/real cash balances remain the same. An increase/decrease in an individual'sdemand for purchasing power itself (real cash balances) can be satiated by liquidating/building up assets. But an increase/decrease in the whole market's demand for purchasing power cannot be satiated in this way. What could it possibly mean for an entire market to "liquidate" its assets? Everyone sells their stuff. But to whom? Each other? That clearly would not increase the market's total purchasing power in the way that an individual liquidating his assets does so for him. The exchange-facilitated productive process across time is not a zero-sum game, but atering real cash balances, in any given snapshot in time, is. To repeat, at any point in time, there is a definite stock of commodities (more production would mean you're not talking about a snapshot in time anymore), and therefore a fixed amount of purchasing power. So at any point in time, one person can only increase his aliquot of the goods and services he can command with his cash balance (in other words sell assets in exchange for purchasing power) if other people decrease their aliquot (in other words, buy assets in exchange for purchasing power) to the same extent.
Esuric,
This is the part that doesn't make sense to me. When we're talking about people demanding, "additional real money balances", we're talking about demanding more purchasing power, right? But how can wanting more purchasing power be "satiated by an expansion in the supply of money" when expanding the supply of money does not expand total purchasing power, since at any given moment, there is a definite stock of commodities (that which one can have the power to purchase) in the market, and therefore there is a fixed, definite amount of purchasing power to go around?
When there is an increase/decrease in the money stock, and the demand for purchasing power remains the same, there will be an increase/decrease in the general market demand for the monetary unit (nominal cash balances). And that can be satiated by dishoarding/hoarding, while purchasing power/real cash balances remain the same. An increase/decrease in an individual'sdemand for purchasing power itself (real cash balances) can be satiated by liquidating/building up assets. But an increase/decrease in the whole market's demand for purchasing power cannot be satiated in this way. What could it possibly mean for an entire market to "liquidate" its assets? Everyone sells their stuff. But to whom? Each other? That clearly would not increase the market's total purchasing power in the way that an individual liquidating his assets does so for him.
The exchange-facilitated productive process across time is not a zero-sum game, but atering real cash balances, in any given snapshot in time, is. To repeat, at any point in time, there is a definite stock of commodities (more production would mean you're not talking about a snapshot in time anymore), and therefore a fixed amount of purchasing power. So at any point in time, one person can only increase his aliquot of the goods and services he can command with his cash balance (in other words sell assets in exchange for purchasing power) if other people decrease their aliquot (in other words, buy assets in exchange for purchasing power) to the same extent.
^ This.
Z.
DD5 in response to Esuric: You're asking to do much more. You're asking to ignore the causal elements in the changes in the money supply. In this particular case, a contraction, but it is just as well the case for expansion. The use of "above the natural rate" or "below the natural rate" are valid in explaining the discoordination only on account of the economist's assumption, made for simplicity of analysis, that the "natural rate" , as a given, is the present desirable rate of the market. (emphasis on desirable). Therefore, it automatically follows that any divergence from this "natural rate" (market rate) constitutes a disruptive divergence, or distortion. However,it also logically follows that this disruptive force must beexogenous. Assuming that the cause can also be indigenous, such as voluntary changes in cash holdings, results in a logical self-contradiction, i.e., if "natural rate" is the rate of the free market, how can there be a divergence from it in the free market?
You're asking to do much more. You're asking to ignore the causal elements in the changes in the money supply. In this particular case, a contraction, but it is just as well the case for expansion.
The use of "above the natural rate" or "below the natural rate" are valid in explaining the discoordination only on account of the economist's assumption, made for simplicity of analysis, that the "natural rate" , as a given, is the present desirable rate of the market. (emphasis on desirable). Therefore, it automatically follows that any divergence from this "natural rate" (market rate) constitutes a disruptive divergence, or distortion. However,it also logically follows that this disruptive force must beexogenous. Assuming that the cause can also be indigenous, such as voluntary changes in cash holdings, results in a logical self-contradiction, i.e., if "natural rate" is the rate of the free market, how can there be a divergence from it in the free market?
And this ^.
And a big fat THIS to Z's last two posts
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DD5:This is correct, but when one increases his cash holdings, is he lowering his spendings on consumers goods or producers goods?
Good point. Do you think it's useful to distinguish between "de-consumption deflation" and "dis-investment deflation"? Perhaps the latter isn't actually deflation at all, though.
DD5:You've indicated before that you acknowledge that time preference can even increase when one increases his cash holdings. Have you changed your mind?
I'm not sure, to be honest. What I'm trying to do is better evaluate Esuric's claim that deflation causes market interest rates to rise above the natural interest rate.
Autolykos:Good point. Do you think it's useful to distinguish between "de-consumption deflation" and "dis-investment deflation"? Perhaps the latter isn't actually deflation at all, though.
No.
Autolykos:I'm not sure, to be honest. What I'm trying to do is better evaluate Esuric's claim that deflation causes market interest rates to rise above the natural interest rate.
First, let me define 'deflation' the way that I think is compatible with how Esuric is using it to avoid misunderstandings. deflation - any cash-induced changes in the purchasing power of money in the upward direction.
Now, can such 'deflation' cause market interest rates to rise above the natural rate of interest?
If 'natural rate' is used in its literate sense, that is, some equilibrium point of the discount rate representing time preference, then Yes, but so what?
The question mises the point. The ongoing interest rate is always above or below some mental construct of a 'natural rate of interest'. The question is not interesting, and Esuric's insight (which is simply a reiteration of the MET insight) is also not too revealing, unless one wishes to emphasize the point about the market as a process.
What is interesting is whether the discrepancy (below or above the natural rate) is due to indigenous forces or exogenous forces. The latter exerting their influence by force against that which would have occurred absent this force, i.e., interference in the free market rate of interest. In other words, what is the causal element behind the deflation? Monetary contraction that results from a reverse inflationary policy? This would also include fractional reserve bank credit rewinding back to its base reserves following a bust. Or is it the result of an increase in voluntary demand for money?
MET fails to distinguish between the causal elements and reach the amazing conclusion that any disequilibrium is tantamount to distortion. This means that fluctuations in demand for coffee are also distortions, just as government price fixing is, because when you plot the supply and demand curves of both - demand for coffee in transition, and for the affect of a price control - both reveal the same shaded areas of disequilibrium.
First let me say that I don't fully understand your argument, Danny, and I've never considered some of the issues that you raise. I will respond to what I think I understand.
Danny Sanchez: When we're talking about people demanding, "additional real money balances", we're talking about demanding more purchasing power, right?
I don't think so. People demand additional cash balances in order to (a) facilitate transactions, or for (b) security (during periods of extreme uncertainty). There are two ways to satiate this elevated demand for liquidity: (1) allow the purchasing power of money to rise via price adjustments (problematic), or (2) expand the supply of money (also problematic, but for different reasons).
Danny Sanchez: n increase/decrease in an individual's demand for purchasing power itself (real cash balances) can be satiated by liquidating/building up assets. But an increase/decrease in the whole market's demand for purchasing power cannot be satiated in this way. What could it possibly mean for an entire market to "liquidate" its assets? Everyone sells their stuff. But to whom? Each other? That clearly would not increase the market's total purchasing power in the way that an individual liquidating his assets does so for him.
This is the point, and this is how Wicksell deduced his "rot" (though he managed to forget that monetary equilibrium can be re-established via price adjustments, i.e., deflation). Under such a condition, you get a general "buyer's market," where individuals simultaneously increase sales, liquidate assets, and limit consumption (elevating market interest rates above the natural rate and yielding deflation). Now, unlike the situation that characterizes an increase in savings, the structure of production does not expand enough, at all, or it may even contract, therefore constricting general economic activity. This makes it so that even warranted investments become temporarily unprofitable (because the interest rate effect is not strong enough to counter-balance the reduced demand effect).
And, again, the downward price adjustments are even, yielding additional problems.
DD5:The ongoing interest rate is always above or below some mental construct of a 'natural rate of interest'. The question is not interesting
It was pretty interesting for Hayek, who wrote many books devoted to this issue alone.
DD5:and Esuric's insight (which is simply a reiteration of the MET insight) is also not too revealing, unless one wishes to emphasize the point about the market as a process.
Which is exactly what I'm doing. My argument analyzes the market as a process; I'm explicitly investigating the implications of such a condition, and how the market reacts and adjusts to this particular set of circumstances.
DD5:What is interesting is whether the discrepancy (below or above the natural rate) is due to indigenous forces or exogenous forces. The latter exerting their influence by force against that which would have occurred absent this force, i.e., interference in the free market rate of interest.
This is actually entirely uninteresting. You're trying to create this endogenous/exogenous distinction when there isn't one. Neither Hayek nor Wicksell nor Mises focused solely on exogenous factors; in fact, Hayek and Wicksell entirely ignored exogenous factors (such as central banks) altogether (their analysis almost exclusively dealt with endogenous factors, within the banking system, that led to inter-temporal disequilibrium).
As far as I can tell, your objection to my theory (which you admit is logically consistent) is due to the fact that it's problematic for Rothbardian monetary theory. Oh well. I'm not interested in dogma.
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
Esuric:Now, unlike the situation that characterizes an increase in savings, the structure of production does not expand enough, at all, or it may even contract, therefore constricting general economic activity.
It was explained to me, by others(and my interpretation may be wrong), that capital expansion can still occur even if active monetary investment does not occur, and everyone hordes money in their mattress's. The expansion is not dependent on monetary investment necessarily, but instead dependent on the freeing up of raw materials and resources to be employed in more remote stages of production, where before they were too costly to be used.
Assuming the following premise.
Esuric:a general "buyer's market," where individuals simultaneously increase sales, liquidate assets, and limit consumption
I'm told that when consumers start behaving in the manner you describe above. Stages of production closest to consumption begin to show widespread losses. However during the same economic time period, stages furthest from production have not yet felt this economic impact, and so their revenues remain unchanged.
During these first series of thrifty time cycles real resources and raw materials have been freed up for use. Prices of raw materials and resources begin to drop. Industries that reside furthest away from consumption now find that they are able to afford and employ various resources that were before not available to them.
It doesn't matter if everyone sits on their money in this case, what matters is the cost of iron and steel dropping. This makes capital expansion far more affordable for business's who operate farthest away from consumption.
So stages of production most distant from consumption are now able to expand. The expansion process is backed by real resources made available, not necessarily monetary investment. In the long run the economy becomes more productive, increasing the abundance, quality, and options available to the consumer which then acts as a counter-measure for the thriftiness.
This is a pretty crude regurgitation of a discussion I had with a friend of mine. I need help understanding how this scenario actually effects the market rate of interest overall as you state. How in this scenario are interest rates suppose to fall? I've been explained once, but I wouldn't mind a brief explanation from you Esuric if you have a chance. And finally, why would interest rates rise in this scenario rather then fall?
I understand how this makes sense, if we isolate our economic peripheral viewpoint to single stages of production, while ignoring others. I don't understand however how we can expect industries furthest from consumption being immediately harmed by the sudden scenario of thrift. And I don't see why they can't take advantage of the new purchasing power, granting them the means to capital expansion.
That or I am mis-understanding several things which I need help rectifying!
Flic: I'm told that when consumers start behaving in the manner you describe above. Stages of production closest to consumption begin to show widespread losses. However during the same economic time period, stages furthest from production have not yet felt this economic impact, and so their revenues remain unchanged.
Please read my entire response (it's a little choppy).
All stages of production, including the highest stages of production (the producer goods industries), are affected by changes in the aggregate demand for final goods and services (the value of capital is, in part, determined by the final demand for the goods they produce) as well as the interest rate. But as you move further away from the final stage of production (when the final consumer goods come to fruition), towards the higher orders of production, the aggregate demand effect becomes less profound (relative to the lower phases of production). In other words, the highest stages of production are more sensitive to changes in the interest rate (interest rate effect) relative to the lower stages, and the lower stages of production are more sensitive to changes in the aggregate demand for final goods and services (the aggregate demand effect) relative to the higher stages of production. I ask that you refer to Hayek's triangle in Prices and Production, on page 228.
Now, as is the case with an increase in savings, the lower stages contract more relative to the highest stages (due to the reduction in total aggregate demand), but because there's a higher supply of real loanable funds, the interest rate falls, and the structure of production expands. Since interest rates fall (again, due to a higher savings rate), and because the higher phases of production are more sensitive to changes in the interest rate (relative to changes in aggregate demand), this change (the interest rate effect) offsets the reduction in aggregate demand, and then some. But this is not the only affect: (1) the original means of production are spread more thinly throughout each stage, of which there are more of (each stage, at the margin, employs less labor), which reduces marginal costs across the board, and (2) there is a higher supply of producer goods which also lowers the cost of inputs, and therefore reduces marginal costs at each successive stage of production (marginal costs across the board). This protects profitability, and actually increases it in the aggregate.
NOTE: This occurs only and precisely because there is an additional supply of real lonabale funds (saving) which allows the structure of production to expand. If the structure of production does not expand, if the market rate of interest does not fall along with the natural rate of interest (since a higher savings rate necessarily means a lower time preference, i.e., a lower natural rate of interest), then only the aggregate demand effect takes hold, and there will be a contraction of economic activity across the board (most dramatic in the lower phases of production, but it will still effect the higher stages of production because the market rate of interest is now above the natural rate). The problem is avoided, again, because the market rate of interest falls along with the natural rate of interest, and the structure of production expands.
But a higher demand for money is not a higher demand for savings. First, because it does not alter the natural rate of interest (if we hold the ceteris paribus condition), and because it actually reduces the total supply of real loanable funds, as individuals withdraw cash from banks, and liquidate their assets (lower demand for securities means higher interest rates in order to stimulate the QD for them). Additionally, and as I've mentioned, individuals will increase sales and limit consumption. So what we get, therefore, is a condition where aggregate demand falls dramatically, and interest rates rise dramatically (a lower supply of lonable funds), so that the structure of production contracts across the board, constricting total economic activity.
The demand for money =/= the demand for future goods (savings). It's important to understand this distinction. Mises specifically distinguishes between the demand for consumer goods (consumption), producer goods (savings), and money (the ratio between the first two determines the natural rate of interest, and the latter (demand for money) is time neutral, but influences/partially determines the market or money rate of interest).
Esuric:First let me say that I don't fully understand your argument, Danny, and I've never considered some of the issues that you raise. I will respond to what I think I understand. Danny Sanchez: When we're talking about people demanding, "additional real money balances", we're talking about demanding more purchasing power, right? I don't think so. People demand additional cash balances in order to (a) facilitate transactions, or for (b) security (during periods of extreme uncertainty). There are two ways to satiate this elevated demand for liquidity: (1) allow the purchasing power of money to rise via price adjustments (problematic), or (2) expand the supply of money (also problematic, but for different reasons).
All 3 of these "separate" goals (more purchasing power, more facilitation of transaction, more security) are essentially about the same thing. As Mises wrote, there is one and only one function of money: to facilitate exchange by serving as a medium of exchange. All other "secondary" functions that economists perorate about are really special instances of the one function.
Mises, TMC: "all of [the "secondary" functions of money] can be deduced from the function of money as a common medium of exchange."
Any desire to facilitate indirect exchange is always due to uncertainty. As I'm sure you know, if there were certainty, there would be no money; there would only be the numeraire tokens of the ERE. Extreme uncertainty is not qualitatively different from any other degree of uncertainty. The degree of uncertainty always plays a role in the demand for money. But it does so only by virtue of its effect on the relative importance, among other desires, of the individual's desire to facilitate exchange with a medium of exchange.
Mises, TMC: "The uncertainty of the future makes it seem advisable to hold a larger or smaller part of one's possessions in a form that will facilitate a change from one way of using wealth to another, or transition from the ownership of one good to that of another, in order to preserve the opportunity of being able without difficulty to satisfy urgent demands that may possibly arise in the future for goods that will have to be obtained by way of exchange."
So when you talk about "facilitating exchange" and "uncertainty" in terms of components of the demand for money, you're really talking about the same thing. The degree of uncertainty is nothing but a factor in determining how much an individual wants to hold his wealth in a form that facilitates exchange vs. in a form that facilitates use or "in-house" production. People holding any cash balances whatsoever are always seeking "security", in that they are always dealing with some degree of uncertainty, and determining the height of their cash balances with reference to that degree of uncertainty. So the (b) component of the demand for money above, is simply part of the (a) component: the desire of people to facilitate exchange by acquiring a medium of exchange.
And the "facility to exchange" that a medium offers is merely another way of saying "purchasing power". That is why Mises writes:
"The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding of a definite amount of purchasing power."
The demand for money is nothing but the demand for real cash balances, and the demand for real cash balances is nothing but the demand for purchasing power. And again, with any given stock of commodities-to-be-purchased, there is only a fixed amount of purchasing power to go around. So while an individual can increase his purchasing power (sell) by virtue of another individual decreasing his purchasing power (buying), the notion of an entire economy increasing its purchasing power (real, and not nominal, cash balances), either via (1) falling prices or (2) more fiduciary media, is nonsensical. The only way for the total purchasing power (real, not nominal, cash balances) of a whole economy to rise is for the stock of commodities-to-be-purchased to expand.
A thought occured to me about the argument proving there is such a thing as not enough money.
The argument goes: Assume 99% of the money we have now just disappears in a puff of smoke. Would you say we have enough? Of course not. Ergo, there is such a thing as not enough money in our current situation as well, if enough people hoard their money.
I don't know if there is a name for that fallacy, so I will name it: Pretending a normal situation is the same in principal as an extreme one.
To show that this is a fallacy, I will prove that there is such a thing as not enough covered wagons right now. Assume 99% of the motor vehicles in the world disappeared in a puff of smoke. Surely we will need covered wagons then. Ergo, we may have a shortage of them right now, if enough people decide to put their cars away in storage.
I hereby rename this silly kind of thinking "The Covered Wagons Fallacy".