Inflation Confusion: Confusing Movement Along v. Shift of the Demand for Money Curve
Is John Tamny trying to discourage me from purchasing a copy of The Financial Analysts Guide to Monetary Policy by Victor A. Canto, Charles W. Kadlec, and Arthur B. Laffer? Well he has succeeded by blaming the following confusion on the authors:
Is there a Laffer curve component to all this? Writing in the early 1980s, economists Arthur Laffer, Charles Kadlec, and Victor Canto alluded to such a possibility, noting that rate hikes “represent an increase in the effective tax rate on the activity levels of Federal Reserve member banks.” Rate increases back then “undermined the utility of the dollar as an intermediary currency,” meaning rate hikes “diminished demand for dollars,” which was itself inflationary. Though yields on 3-month Treasury bills reached 16 percent in 1981, the rate of inflation rose substantially.
For some reason – the National Review is opposing the recent tight monetary policy from the Federal Reserve on the fear that higher interest rates will actually increase inflation. Now I’m hoping the Federal Reserve loosens its monetary policy as I fear it might lead to another recession – albeit I can understand the FED’s concern that fiscal stimulus is still out of control. Yes, Laffer would tell you that tax cuts, which leads to less savings if people consume more, don’t crowd out investment, but he’s wrong.
Let’s try to follow Tamny’s “logic”. An inward shift of the money supply curve raises the price of credit (the interest rate) which lowers the quantity demand for money. Now if one was drunk during the first lecture in Economics 101, one might have imagined that the money demand curve shifted inward. And an inward shift of the money demand curve would increase aggregate demand etc. But once one sobered up and re-read the textbook – one would realize how utterly stupid Tamny’s thesis really is. Now if Canto, Kadlec, and Laffer are actually including the insane musings of a drunken fool in a Guide to Monetary Policy, I’m not wasting my time or money on it.
Incidentally, the tight monetary policy during the early 1980’s did lower inflation despite the fiscal stimulus from the 1981 tax cut – which did lead to crowding-out of investment and slower long-term growth. Something else a drunk might never realize as listens to Laffer’s BS and thinks it’s real economics.
Update: Mr. Tamny’s most recent comment (1:30 PM) now says money demand rose whereas his op-ed talked about a decrease in money demand. Before that – he notes that tight monetary policy does not lower inflation as it does not lead to dollar appreciation. Let me assure Mr. Tamny that the tight monetary policies of the early 1980’s lead to a substantial appreciation of the dollar. I’m sorry but Mr. Tamny is utterly confused as to the facts as well as what he wrote.
Update II: Many thanks to David Altig for reminding us of the Wright Patman effect. The particular paper that I’ve linked to has as part of its summary:
This paper has presented an empirical test that provides evidence to support the contention that monetary policy has supply-side effects on real variables. The evidence given here shows that in key manufacturing industries, prices rise and output falls following an unanticipated monetary contraction, even after controlling for both the price puzzle and the cost effects of oil shocks. Further, the results call into question whether a price puzzle even exists. We find that the evidence for cost channel effects is much stronger during the period from 1959 to 1979 than from 1983 to 1996.