About That, er, Monetary Expansion…

Brad DeLong has a spat with Scott Sumner:

The IS-LM model led economic historians to argue money was easy in 1929-30, because rates fell sharply. It led modern Keynesians to assume that money was easy in 2008, because rates fell sharply…

Well, I would say that not just “modern Keynesians” but a lot of people believed that monetary policy was expansionary in 2008.

They believed so not just because (safe) nominal (and real) interest rates were falling, but because the money supply was expanding. Indeed, since 2007 the Federal Reserve has tripled the monetary base

But there remains a reason I suggest that cutting off Tim Geithner’s (and/or Ben Bernanke’s) private parts, stuffing them into his mouth, and perp-walking him publicly down Dewy Square* would be a good re-election move for the Obama Administration, and it comes back to basic economics. Specifically, Brad DeLong’s favorite monetary equation


Now, most of the time, we derive V—Velocity. We kinda sorta hafta. The velocity of money is not something that you really observe directly; to solve the equation for V(i), we have to know Y, P, and M.

But then we’re making assumptions about them. Two of them are probably reasonable:

Y = GDP (or GNP if you add in XM, but let’s not). We shorthand this as “aggregate output.” Even if we weren’t pretending it’s constant in the short-term, we can fairly well define this and hold to the definition. GDP=GDP, as it were.

P = Price Level. This is slightly more difficult conceptually, because we aren’t going to include everything. But if we assume (short-term) that the “market basket” is constant (or at least fungible**), we can come up with a representative index level and just treat this as “inflation.”

The third, however, is more problematic:

M is the Base Money Supply, which is circulating.

Recall that V = Velocity, or, the number of times in a year that a dollar is spent, a definition that led to Keynes’s observation that V isn’t so much a constant (pace Fisher) as dependent on interest rates—V(i). This doesn’t (or, more accurately, shouldn’t) change much in the short-term, even at the zero-bound.

But “velocity” assumes money is circulating, which why it is multiplied by the Monetary Base from the start. If the monetary base has all the mobility of an overBotoxed actor’s face, we’re going to have a problem. I would call the following graphic “Where’s the Real Increase in the Monetary Base?”

The above graphic is Ben Bernanke’s fault. And even Brad DeLong knows this. The proof below the fold.

Or, at least, he strongly suggests he does, citing WSJ columnist David Wessel:

The Fed is not out of ammo, the economists at the Bank Credit Analyst insist…

The three:

Target a higher inflation rate or pre-specified level for the consumer price index or nominal gross domestic product. Problem: “could undermine the Fed’s long-standing commitment to price stability.”

Stimulate bank lending by putting a tax on excess reserves, hoping that banks will the lend out the money if the have to pay borrowers to take the loans. Problem: “could lead to the collapse of money market funds and the disintermediation of the financial system.”

Buy corporate debt, equities, real estate or foreign currency. Problem: Could require an act of Congress. “Given that the U.S. economy remains stuck in a liquidity trap,” Berezin concludes, “fiscal policy would be the most straightforward way to stimulate….However, the likelihood that the U.S. will receive major fiscal stimulus anytime soon is close to zero.”

I’m not sanguine about the latter. Even absent economic issues (which are minimal in the current environment), the political ones are problematic.*** That it makes more sense than telling people to put their money into a 401(k) that consists 90% of company stock is a low bar to jump. On the other hand, buying Yuan until it has to appreciate is worth exploring.

The first has been getting traction for years. And I admit I can’t decide who was stupider: the people who set a 2% target on no evidence (sorry, David, I held to this even after reading your cites) or the people who decided a “2% target” meant “<=." It now has enough traction that it will get out of the avalanche about the time the snow melts. So that leaves the second one. Which brings us back to the Monetary Equation problem. Recall that the definition of Velocity is "the number of times in a year that a dollar is spent." I buy something at the Dollar Store, they use that dollar to buy more products and pay employees, the suppliers and employees buy more supplies and other products, respectively, etc.**** So Brad DeLong ("I see no risks in attempting any of these three--and great risks in continuing to dither") agrees with Peter Berezin of Bank Credit Analyst (and me) that we don't want banks holding Excess Reserves as a matter of monetary policy at the zero bound. Fundamental principle of economics: you want to tax things you wish to discourage. You want to subsidize things you wish to encourage. As the Rabbi once said, "All else is commentary." So what did the Federal Reserve do in the face of a desperate attempt from the Fed to stimulate the Base Money Supply?

The Financial Services Regulatory Relief Act of 2006 originally authorized the Federal Reserve to begin paying interest on balances held by or on behalf of depository institutions beginning October 1, 2011. The recently enacted Emergency Economic Stabilization Act of 2008 accelerated the effective date to October 1, 2008.

Employing the accelerated authority, the Board has approved a rule to amend its Regulation D (Reserve Requirements of Depository Institutions) to direct the Federal Reserve Banks to pay interest on required reserve balances (that is, balances held to satisfy depository institutions’ reserve requirements) and on excess balances (balances held in excess of required reserve balances and clearing balances).

this lead to something that will surprise no economist of any caliber, let alone a Professor at Princeton:

By the time of the stimulus, roughly that amount had been taken out of circulation as the change in Excess Reserves. Even if every cent had been well-allocated, it was already out of circulation.

Ben Bernanke giveth, but Ben Bernanke taketh away even more, in spades.

What Monetary Stimulus?

*Again, I don’t encourage this action. But if you think I can’t create or find a suggestion for each of the Occupy locations, you haven’t read and seen enough Jacobean drama.

**Whether we replace my wife’s three-year old mobile with either a “free” Droid or a “free” iPhone 3GS probably doesn’t have a significant effect. Economists pretend that the “steak-chicken” model is similar.

***Short version: You think the tempest-in-a-teapot that is Solyndra is getting discussion? Try that times ten when three or four REITs and a few companies go under. (Amazingly, those who complain about the “low” return on Government securities also loudly complain when the Government invests in non-risk-free securities.)

****It is left as a side-note that increasing the Velocity of Money is yet another way to reduce tax rates, all else equal. It is also left as a side-note that people who talk about “double taxation” of (voluntarily disbursed) dividends are economic ignoramuses, and that there are many economists who talk in that manner in no way invalidates the first half of this sentence.

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