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
Esuric 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.
Esuric
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.
I apologize if you have already answered this earlier in the thread. If consumption spending per se has no direct influence on the rate of interest, doesn't this mean that the proportion (or ratio) between consumption and investment spending doesn't strictly determine the rate of interest? A lower amount of consumption spending relative to the same fixed investment spending certaintly lowers this proportion, but as you said it won't affect the rate of interest unless investment spending increases (this was a view I had a hard time accepting, mainly because non consumer loan consumption spending isn't present at all on the time market curve in Rothbard's MES on p418). If so, then perhaps Rothbard might have glibly wrote that when an individual builds up hoards "from funds that formerly went into consumption.....[this] will bring about a fall in the rate of interest" (MES p789)?
Smiling Dave: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".
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".
It's actually a continuum fallacy or a "fallacy of the beard".
Danny, great explanation. My only question is: do those who choose to hold larger cash balances realize they're actually demanding (in effect) greater purchasing power?
DD5, I plan on responding to you soon.
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Autolykos:Danny, great explanation. My only question is: do those who choose to hold larger cash balances realize they're actually demanding (in effect) greater purchasing power?
The don't know the terminology and the analysis, but, yes, anyone who deliberately liquidates assets to increase his cash balance, knows that the whole point in doing so is to have the flexibility to buy stuff.
Danny Sanchez:The don't know the terminology and the analysis, but, yes, anyone who deliberately liquidates assets to increase his cash balance, knows that the whole point in doing so is to have the flexibility to buy stuff.
Ah, I get it now. I was getting confused over people demanding more purchasing power vs. the actual purchasing power of money. Maybe it's useful to talk about "relative purchasing power" (i.e. one's ability to engage in exchanges) vs. "absolute purchasing power" (i.e. how many goods a given quantity of money can be exchanged for). It also seems to me that the latter is equivalent to the notion of "price level" in other schools of economic thought.
Esuric:Neither Hayek nor Wicksell nor Mises focused solely on exogenous factors;
With all do respect to Wicksell, who had had made his contribution to Austrian theory, the theory of the trade cycle does not begin and end with Wicksell.
Mises theory is more complete, although certainly not the final word. It is implied in Mises' theory of the trade cycle that it is only government tampering with interest rates that causes the cycle. Not market fluctuations in cash balances. Rothbard, btw, had not much more to add to this.
Esuric:their analysis almost exclusively dealt with endogenous factors, within the banking system, that led to inter-temporal disequilibrium
Hayek mainly attributes the trade cycle to the multiplier factor of the banking system. The multiplier factor is not an inherent feature of free banking! And he also blames the central bank.
The disequilibrium is a problem only on account of the assumption being made, for the sake of simplicity of analysis, that the market rate of interest is at its equilibrium point. It makes no sense to abstract from this that every disequilibrium is now a problem.
Esuric:As far as I can tell, your objection to my theory (which you admit is logically consistent)
Are you even reading my criticisms? You are being totally logically inconsistent.
In fact, saying "disequilibrium is a problem" is no theory at all. It's nonsense! How can a mere disequilibrium for anything automatically indicate a problem? Unless one fails to understand that equilibrium is not a realizable, nor desirable, state of the market.
From a praxeological perspective, what is the difference [ on a free market] between a disequilibrium for coffee and a disequilibrium for money? Assuming you will not consider the former a problem, it follows that we apparently have two sets of economics; one for money and one for coffee and all other goods.
The problem is a mismatch between the temporal plans of entrepreneurs and the temporal plans of consumers. It's a mismatch between the interest rate signal and the real time preference of 'society'. This attempt by MET to abstract the problem to one of "monetary disequilibrium" is a major retrogression in the Austrian theory of the trade cycle.
Esuric: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.
If aggregate demand falls dramatically, so do prices. And if prices drop, so does demand for your "loanable funds", and the interest rate need not rise above the "natural rate".
Now, obviously nothing happens instantly. But pointing this out and labeling it a problem is a non-sequitur. If things were to happen instantly, then there would be no entrepreneurship and no market process. The changes you describe in your example, such as lower aggregate demand, is what will induce entrepreneurs to bid the interest rate down to compensate for a lower nominal reservoir of savings that also resulted from the increase in cash holdings, as per your example. And it is their entrepreneurial action that will adjust the interest rate and eventually all other prices. Not the other way around, i.e, prices adjust and then action is taken. This is what your theory implies - that entrepreneurs are unable to calculate until monetary equilibrium is reached. This is totally incompatible with Austrian price theory.
The important point to understand here is that the changes in economic activity, such as voluntary increase in demand for money, is by definition, aligned with changes in consumer preferences, so that signals are guiding entrepreneurs in the right direction. It is nonsense to say that there is a problem of "above" or "below" some natural rate, like in the case of monetary inflation (or deflation). The latter are temporary changes in demand brought about by force and not by consumer change in preferences. Like some kind of a concealed subsidy, they do not reflect any permanent changes in consumer preferences. It is only the latter [temporary coercive activity] that guides entrepreneurs astray.
Potentially relevant.
http://consultingbyrpm.com/blog/2011/01/i-demand-answers-from-the-aggregate-demanders.html
Danny Sanchez: 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.
Yes, but during periods of extreme uncertainty, such as financial and economic catastrophe's, individual's tend to demand the most liquid commodity (money) for safety. Do you deny this?
Danny, it seems like you're trying to conflate the demand for money with the demand for wealth in order to invalidate the concept with a crude version of Say's law (the only way to consume more is to produce more). But the desire to hold money is not the desire to consume. In fact, when you consume, you're expressing a diminished demand for money. The term "purchasing power," in economics, refers solely to the value of money. Thus when you claim that it's impossible for the whole economy to increase it's purchasing power, you're saying that the value of money cannot rise, or, in other words, that deflation is impossible (unless you're using the term "purchasing power" in a different sense).
Autolykos: It's actually a continuum fallacy or a "fallacy of the beard".
According to Wiki, the continuum fallacy is when "one erroneously rejects a vague claim simply because it is not as precise as one would like it to be. Vagueness alone does not necessarily imply invalidity."
When did I do this?
DD5: It is implied in Mises' theory of the trade cycle that it is only government tampering with interest rates that causes the cycle.
Absolutely ridiculous and simply incorrect. The ABCT is meant to explain all cycles, even those that occurred in monetary systems that did not posses central banks and where the government did not tamper with interest rates. The ABCT can explain this recession as well as the 1890 recession in free banking Australia. Hayek specifically said that recessions are unavoidable precisely because inter-temporal disequilibrium is unavoidable.
Again, rather than dealing with my actual argument, you're trying to dismiss it by creating this absurd endogenous/exogenous distinction (and you're treating FRB as an exogenous variable, for some strange reason). It simply doesn't exist.
DD5: The multiplier factor is not an inherent feature of free banking!
Except that there's no proof for this assertion at all.
These are the facts.
DD5: If aggregate demand falls dramatically, so do prices. And if prices drop, so does demand for your "loanable funds", and the interest rate need not rise above the "natural rate".
I don't understand what you're trying to say here. A lower demand for securities means higher market interest rates, not lower market interest rates. There's an inverse relationship between the demand for securities and the market interest rate. But what's the relationship between the general price level of consumer goods and market interest rates? There isn't one; market interest rates can rise when prices fall, and they can fall when prices fall.
"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."
Autolykos: It's actually a continuum fallacy or a "fallacy of the beard". According to Wiki, the continuum fallacy is when "one erroneously rejects a vague claim simply because it is not as precise as one would like it to be. Vagueness alone does not necessarily imply invalidity." When did I do this?
You did use the fallacy of the covered wagon. It's explained in an earlier post, together with the instance you used it [on another thread].
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It's easy to refute an argument if you first misrepresent it. William Keizer
Esuric: DD5: The multiplier factor is not an inherent feature of free banking! Except that there's no proof for this assertion at all.
I'm referring to the multiplier factor,which is an inherent part of government intervention, i.e., central banking and such.
It is not part of the free market, even if fractional reserve banking existed. See Mises in Human Action. Or even George Selgin's "The Theory of Free Banking....."
Esuric: 1. Fractional reserve banking emerged naturally through free market activity 2. You're going to have to prove that all individual's would rather pay "storage fees" rather than earn interest and have their cash available on demand 3. The only time that a 100% reserve ratio was employed was during the 13th century in the Middle East due to religious decree (it was forced).
1. Fractional reserve banking emerged naturally through free market activity
2. You're going to have to prove that all individual's would rather pay "storage fees" rather than earn interest and have their cash available on demand
3. The only time that a 100% reserve ratio was employed was during the 13th century in the Middle East due to religious decree (it was forced).
Wrong debate. Not relevant to anything.
Esuric: I don't understand what you're trying to say here. A lower demand for securities means higher market interest rates, not lower market interest rates.
I don't understand what you're trying to say here. A lower demand for securities means higher market interest rates, not lower market interest rates.
ceteris paribus, that would be correct. However, that is not the only condition of the problem at hand, which you had provided. There is a lower demand for goods also:
Esuric: But what's the relationship between the general price level of consumer goods and market interest rates? There isn't one;
But what's the relationship between the general price level of consumer goods and market interest rates? There isn't one;
There isn't one? How can there not be one if even you acknowledge that eventually, the market rate of interest would adjust? So even you have to acknowledge that there is a connection, or you must argue that the rate of interest will be above the "natural" rate forever!
For one thing, the fall in monetary demand for consumers goods has an immediate effect on the level of real wages. The decline in prices of final consumer goods will be followed by a rise in the real wages of workers employed in all stages of production. This exerts downward pressure on demand for savings, and interest rate. There is also a fall in prices expected in producers goods, which will also exert downward pressure on interest rate. All of this will offset the fall in nominal savings. In short, entrepreneurial action will adjust relative prices, which will further guide entrepreneurial action in the right direction.
What is amazing is that In your models, only the interest rate adjusts too quickly, but nothing else. How can this be? Entrepreneurs are a bunch of idiots, actually they might as well not even exist in your models, for they speculate on nothing according to you. Only the bank adjusts its interest rate automatically, but also, with no entrepreneurial foresight.
Esuric: you're trying to dismiss it by creating this absurd endogenous/exogenous distinction
you're trying to dismiss it by creating this absurd endogenous/exogenous distinction
What is absurd is the claim that a disequilibrium, and no further explanation, is a problem always and everywhere. Even more absurd is that it is a problem for entrepreneurs, since let's not forget that ABCT is about entrepreneurs going astray, and entrepreneurs themselves only exist on account of such disequilibrium.
Esuric: Danny Sanchez: 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. Yes, but during periods of extreme uncertainty, such as financial and economic catastrophe's, individual's tend to demand the most liquid commodity (money) for safety. Do you deny this?
No. But, during those periods, the way people are dealing with the extreme uncertainty is by increasing their facility to exchange. So what I'm saying is that that is only quantitatively, and not qualitatively, different from any other period, because people always increase or decrease their facility to exchange according to the present degree of uncertainty. So, the two components of the demand for money that you posit are really one and the same component.
Esuric:Danny, it seems like you're trying to conflate the demand for money with the demand for wealth
I am not doing any such thing. When I'm talking about an increase in an individual's demand for money, I'm not talking about an increase in his demand for wealth; I'm talking about his desire to, as Mises says in what I quoted before, effect "a change from one way of using wealth to another".
Esuric:Thus when you claim that it's impossible for the whole economy to increase it's purchasing power, you're saying that the value of money cannot rise, or, in other words, that deflation is impossible (unless you're using the term "purchasing power" in a different sense).
The purchasing power of the monetary unit, across the whole economy, can rise, but only to the extent that either (a) more goods are produced, or (b) there are fewer monetary units. As I've already said, if (a) occurs, that means there are more "commodities-that-can-be-purchased", so the total purchasing power to go around can go up. But if (b) occurs, there is deflation, but there is not more purchasing power for the whole economy. This is because, while the purchasing power of the monetary unit has gone up, the number of those monetary units has gone down. It is simply logically impossible for there to be more total purchasing power in the economy as a whole unless there are more goods in the market as a whole to be purchased. How can everybody purchase more goods, if there aren't more goods to be purchased? And again, the purchasing power of the monetary unit is not the same thing as the purchasing power present in the whole economy.
Well said, and obvious AFTER you say it.
The above also refutes Esuric's q, "If deflation is so great, why can't the govt just burn up dollar bills and we all get richer"?
IF the govt did that, we would be neither richer nor poorer. But if it prints more money, it makes some people richer [=the printers and their pals] at the expense of others [=everyone with paper money in his wallet or bank account or future paycheck].
In any case, in the real world, deflation rarely happens because of (b). It's always because of (a). And anyone who wants to "solve our problem" of being wealthier by printing money, good luck to him.
DD5: I'm referring to the multiplier factor,which is an inherent part of government intervention, i.e., central banking and such. It is not part of the free market, even if fractional reserve banking existed. See Mises in Human Action. Or even George Selgin's "The Theory of Free Banking....."
Oh okay, I understand what you're saying and it's a very good point. In fact, I've been struggling with this very same issue myself, and I think it's because I'm only familiar with how this monetary system operates. For example, a lower demand for money constitutes a higher velocity which allows banks to increase the supply of money in the broader sense, and this yields general price inflation, but I'm not sure how a lower demand for money elevates prices in different monetary systems. Conversely, a higher demand for money, in our current monetary system, means a contraction in velocity, which reduces the total supply of money in the broader sense, and yields general price deflation.
I'm not really a free banker, and I've said this on multiple occasions. I've never actually read Selgin or White's work on this issue (I've only read a couple of articles), and I find it fairly problematic in many respects. These are the issues I have with free-banking:
But I believe that my explanation regarding the effects of a particular type of inter-temporal disequilibrium (market rate elevated above the natural rate), caused by monetary disequilibrium, is still logically sound (it's merely a deduction from the Mises-Hayek-Wicksell business cycle framework).
Danny Sanchez: The purchasing power of the monetary unit, across the whole economy, can rise, but only to the extent that either (a) more goods are produced, or (b) there are fewer monetary units. As I've already said, if (a) occurs, that means there are more "commodities-that-can-be-purchased", so the total purchasing power to go around can go up. But if (b) occurs, there is deflation, but there is not more purchasing power for the whole economy. This is because, while the purchasing power of the monetary unit has gone up, the number of those monetary units has gone down. It is simply logically impossible for there to be more total purchasing power in the economy as a whole unless there are more goods in the market as a whole to be purchased. How can everybody purchase more goods, if there aren't more goods to be purchased? And again, the purchasing power of the monetary unit is not the same thing as the purchasing power present in the whole economy.
This is correct. I don't really know how to respond to this because I'm failing to grasp the implications. But I still don't think it's accurate to equate the demand for liquidity with the "demand for purchasing power."
Esuric: This is correct. I don't really know how to respond to this because I'm failing to grasp the implications. But I still don't think it's accurate to equate the demand for liquidity with the "demand for purchasing power."
Well, the purchasing power of money is, again, just another way of saying the facility to exchange with a medium. And just like the "secondary function" of desiring security is really part of the one true function of money (facilitating exchange via a medium), liquidity is also not really a separate function of money in terms of explaining its demand either.
What makes a good a useful medium for the facilitation of exchange is its liquidity (or "saleability" in Menger's terminology, and "marketability" in Mises'). Saleability/marketability/liquidity is the promptness with which a good can be exchanged anywhere in the market at an exchange-ratio near to the best exchange ratio attainable at all (see Menger's essay on the origin of money).
From the very beginning of a good acquiring any usefulness for indirect exchange at all (even before it becomes the general medium of exchange), it does so by virtue of its saleability/marketability/liquidity. And every step of the way toward the good becoming the general medium of exchange is supported by its ever increasing saleability/marketability/liquidity as it becomes more and more commonly used. (See what I write in my guide to TMC chapter 1 about the "upward spiral of marketability" responsible for a medium of exchange becoming money.)
Since the saleability/marketability/liquidity of a good is what gives it its purchasing power, the demand for saleability/marketability/liquidity is at bottom the demand for purchasing power. You cannot create more total purchasing power on the market as a whole with a change in the number of monetary units, and so you cannot create more total saleability/marketability/liquidity on the market as a whole with a change in the number of monetary units.
Please re-read the post above. Just fleshed it out a bit more. Thanks.