The money quandary
The Federal Reserve, the Bank of England, and the Bank of Japan are considering further quantitative easing. It’s an explicit statement, as with the Federal Reserve and the Bank of England, or implied by the fact that the foreign exchange intervention will eventually be sterilized if the policy rule is not changed, as with the Bank of Japan. Why more easing?
In response to this question, BCA Research (article not available) presented a version of the quantity theory of money. They looked at the simple linear relationship between the average rate of money supply growth (M2) and nominal GDP growth (P*Y).
The chart is a reproduction of that in the BCA paper, but with a sample back to 1959 (they went back to the 1920’s when M2 was not measured). The relationship illustrates the 5-yr compounded annual growth rate of money (M2) against that of nominal GDP, and has an R2 equal to 50% – okay, but not perfect.
Nevertheless, the implication is pretty simple: the current annual growth rate of M2, 2.8% in August 2010, corresponds to an average annual income growth just shy of 4%. Sitting beneath a behemoth pile of debt relative to income, 4% nominal GDP growth is unlikely provide sufficient nominal gains for households to deleverage quickly or “safely“.
However, notice the 2000-2005 and 2005-2009 points, where the relationship between M2 and nominal GDP growth deviated away from the average “quantity theory” relationship. Would a broader measure of money account for the weak(ish) relationship in the chart above? Yes, partially. (Note: the relationship almost fully breaks down at an annual frequency.)
These days it’s all about credit. I’m sitting in Cosi right now – bought a sandwich and charged the bill on my credit card. Actually, I prefer to use cards. But M2 doesn’t account for this transaction as money if the balance is never paid in full. M2 is essentially currency, checking deposits, saving and small-denomination time deposits, and readily available retail money-market funds (see Federal Reserve release).
One can argue about the merits of including credit cards balances as “money”, per se. However, the sharp reversal of revolving consumer credit, and likely through default (see the still growing chargeoff rates for credit card loans), would never be captured in M2. The hangover from the last decade of households using their homes as ATM’s (i.e., home equity withdrawal) and running up credit card balances to serve as a medium of exchange is dragging nominal income growth via a sharp drop in aggregate demand.
The Federal Reserve discontinued its release of M3 in 2006, which among other things included bank repurchase agreements (repos). Including M3, rather than M2, in the estimation improves the the R2 over 30 percentage points (to 81%).
This is a very small sample, and removing the latest data point from the original estimation improves the R2 slightly to 64%; but clearly there’s something going on here. I think that it’s fair to say that we may be disappointed by the M2 implied average nominal GDP growth rate over the next 5 years (4%).
According to John Williams’ Shadow Statistics website, M3 is still contracting at (roughly because I don’t subscribe to the data) 4% over the year. The relationship in the second chart implies that nominal GDP will fall, on average, about 4.5% per year. Japan’s nominal GDP never contracted more than 2.08% annually during its lost decade, but the implication is that “things” may not be as rosy as the M2 measure of money suggests.
Is the implication of credit contraction different when much of the contraction is default on outstanding debt? The Fed’s consumer credit data continues to show credit contracting, but some recently published work suggests contraction through several quarters was as rapid as it was mostly because of default, while more recent credit contraction is more because of less new debt being taken on. In the simple money-growth-to-GDP view, does it matter whether the slowing in credit use is associated with fewer transactions?
My electronic transaction preferences are as follows. For most day to day spending I use a debit card. I can get “cash back” from debit card transactions at grocery stores or the Wal-Mart Supercenter. This is how I maintain the nominal $100 cash that I usually can find in my wallet. I still buy all my sub sandwiches with cash, and I hope I never have to change that. This allows me to just use an internet bank which is generally a better deal that a brick and mortar local bank branch. All my recurring bills (3) are paid automatically from my internet bank checking account. I use a credit card when buying something on the internet, because you do get the ability to stop payment if a store doesn’t deliver. The credit card is issued by my internet bank and I have my checking account set up to autopay the credit card in full when due.
So are debit card transactions in M2?
Also, Nominal GDP growth isn’t going to help anyone pay their bills, unless it is accompanied by Real GDP growth, and then that Real GDP growth is more or less evenly distributed amongst whomever it is that needs to spend money and pay bills. But that’s obvious, isn’t it?
Why stop with short term credit? How about default on home equity loans, 1st and 2nd mortgages, or non-payment on mortgages because F&F and banks have been delaying foreclosure proceeding in many cases?
It all sounds like money to me. Of course, we have heard that this is getting transformed into long term USG debt behind the scenes, so once the taxpayer pays that back, using dollars (which is why we think dollars are worth something, of course), then we can take comfort in the fact that those dollars are “destroyed” by the USG, and then everything is cool again.
So maybe there is a grand plan, and we shouldn’t worry about this stuff so much.
The difference would be in the definition of various kinds of money. There is an implication of transactions rather than a transaction in most money. Turn-over. A mortgage can be used as collateral in higher velocity financial activity, but is not all that liquid itself. “Revolving” credit is assumed to revolve.
Of course, that says nothing about the implication of default. There may be more similarity than difference between a default on revolving credit and mortgages than difference. I haven’t thought it through, but I’d bet others have.
The problem with absolute statements is that they are always wrong. (<= See?) Money supply is far from “meaningless”. Some views of money attach one meaning, others disagree and demand another. The argument can give the impression that one view belies the meaning of money utterly, but that is the wrong impression.
“Warren Mosler, internationally renowned financial and job creation expert…” Never heard of him, which kinda makes the claim of international renown “meaningless”, if you’ll pardon the expression.
From the bombast evident in much of what I found there, I’m gonna guess his “renown” will evaporate everytime time his webhost runs into problems.
Sure. M0, M1, M2 and M3 are largely defining a range of relative liquidity, and long term debt/credit is excluded because it is not “money”.
But I think default is money, and I think the Fed does too and that’s why we have QE.
I don’t know how many others have come up with a Unified Theory of Money Supply and Defaults, but it is quite common to hear that “debt relief” is necessary for economic recovery from the situation that we find ourselves in now. I just like putting that statement in layman’s terms so we understand what that means exactly.
I think he’s the unofficial head of the MMT gang. I also think his money supply (and of his cohort website people like Bill Mitchell) is dependent on Web Hit Transactions, which is why we see their minions on econ blogs everywhere plugging that crap.
I’m sorry – but this article was not an “expalnation of QE”. Nor is money “meaningless”. It’s a symptom of the underlying desire to save, which by the way is an important input to government policy.
But as an aside, I agree – QE will not do anything to create demand. The credit channels are stuffed with unemployed workers and bankers that don’t know which way is up in the regulation world. The credit channel to economic growth is going to be very very slow for some time. We need domestic investment and spending via fiscal policy.
Default IS money? See, I knew what Clinton meant when he talked about the definition of “is”. Which “is” are we using here?
Default is the failure to pay an obligation. That failure cannot, in itself, fund the purchase of chewing gum, so failure isn’t money. It may, however, free up money for other uses, most of which involve turn-over for somebody. Default reduces the value of some asset, an asset which is often collateral in some other financial transaction. Credit default swaps are triggered when mortgages go unpaid. So I can see how default reduces the velocity of money by damaging assets. I can also see that the money which the debtor fails to pay may go toward some other transaction, thereby fostering further transactions, but I think that is probably true of mortgage payments, as well.
So I can see default leading to both more and fewer transactions. If what you mean by saying default is money is that mortgage payments end up being used to pay for other economic activity, we still need to see whether the net change in economic transactions is positive or negative.
But maybe I’m following a path here you aren’t even on. Which “is” are we talking about?
Ya, I’m using the slang version of “is” which very loose, and I do it so people like you type up the long version. But I think what happens is what you describe.
I’ll try it with a slightly different slant. The deadbeat gets to spend money that would have otherwise gone to the mortgage. Wiping out debt also wipes out capital, so this causes a contraction in new credit available. The FDIC, Fed and Treasury steps in at that point with direct bank bailouts, depositor insurance and indirect cash infusions via QE.
Now it may be an intellectual curiosity to try and figure out exactly how this impacts quantity and velocity of money, both in a liquidity trap and outside of one, but I don’t think we get to do it twice, so from a pragmatic point of view we may not need the theory. On the other hand, I will never believe any economic data from this period ever again.
I’ll say it again and again. Contrary to economic theory and Nobel Laureate Milton Friedman, monetary lags are not “long & variable”. The lags for monetary flows (MVt), i.e., the proxies for (1) real-growth, and for (2) inflation indices, are historically (for the last 97 years), always, fixed in length. However the lag for nominal gDp (the FED’s target?), varies widely.
It’s a scientific fact that economic forecasts are mathematically infallible. Nominal (gDp) will cascade in the 4th qtr (down in every month – Oct, Nov, Dec & ending in Jan), without fiscal/monetary, countervailing, intervention/stimulus. That’s why QE2 will start in Oct. & end in Jan. (because of the proxy for inflation).
And the “HOLY GRAIL’ encompases credit & debit card transactions.
OC, one difference between the historical record and now is the amount of money created by QE which is out of circulation. Would things be different if the same amount of money had been created by the gov’t deficit?
There are several economists explaining the approach in a reasonable way, one of which is to determine empirical information. The topic has been explored a little at Naked Capitalism thaty I know of. Perhaps it can be explored here…as traditional economic theory is flattened new proposals arise.
I read the NC Bill Mitchell piece. He and Randy Wray are the two most quoted academics I’ve seen. Auerback makes similar sounding noises at times. You have to know what to listen for. I think Mosler was a stock or bond trader.
The problem with them is they put you thru this long verbose explanation of how the world works, and if you decide to put in the hours and hours to get thru that (I stopped when they got to all their nifty catch phrases-see if you can identify any in my post above-I do that for fun whenever I think any of them may be around.) when you get to the end all they have to say is governments with fiat currency can borrow all they want because they can pay it off with the printing press.
No big news there.
Rats….I can’t edit this easily. Sorry.